Tuesday, November 29, 2011

Restrictive Covenants

Next segment in our Leasing Series…Restrictive Covenants.

Restrictive Covenants (RC) are always an interesting point of negotiation between Landlord and Tenant in working out a commercial lease deal. Rather than pick sides, let me try to give you the differing perspectives for both parties.

If you are a Tenant, you would like to ensure that the Landlord does not put you head-to-head with a similar operation within a commercial complex. For instance, if you are setting up a new hair salon, you would prefer to have ‘exclusivity’ on your use within this location. In your RC, you would cover off the key elements of your operation – ie. hairstyling and aestetics. Practically, these areas should represent the ‘bread and butter’ of your business and they cover a high percentage of your total sales. At the end of the day, you become the one and only ‘Hair Salon’ in this particular development.

If you are the Landlord, you want to ensure you are not allowing RC’s that create problems in bringing in other quality tenants. Going back to the hair salon example, you might want to allow a restrictive on the ‘hairstyling side’, but only for women or not on the aestetics side. This would allow you then to bring in a separate ‘nail salon’ or a ‘traditional barber shop’. The most challenging RC’s for landlords, are generally those that are too broad and cover too many areas, thereby precluding a host of other uses. Although not always easy to do, landlords typically try to respect the tenant’s main business focus, but are not as willing to allow restrictions on their secondary business lines.

As a final note, this will again vary property to property, and generally RC’s get harder to incorporate into a lease, the larger the commercial property gets. In a larger commercial setting, competition is seen as good and this includes in-line competition.

Again seek out experienced commercial realtors with strong leasing backgrounds, to assist you in negotiating ‘restrictive convenants’ that suit your purposes.

Tuesday, November 22, 2011

Additional Rent/Operating Costs

Next segment in our Leasing Series…Additional Rent/Operating Costs.

Additional rent is the other half of the rental amount that applies to commercial premises. Again in industry terminology, this is most often referred to as the ‘operating costs’ of the property. It includes realty taxes, building insurance, maintenance/management costs, janitorial expense, and any other related costs which support the operation of the property. It is applied as a proportionate share of the tenant’s space, relative to the size of the overall property (or building square footage). Simply put, if a tenant occupies 10% of a building, they pay 10% of the total operating expenses, as additional rent.

When considering ‘Additional Rental Costs’ on properties, the amount is represented on a dollar per ft. basis. Additional rent costs, although included on line with most MLS listings, are not as prominent on listing summaries. After doing the net rent comparision - tenants need to make sure they compare the additional rent factors, so as to have a handle on the total monthly cost.

A budget breakdown of additional rent costs, should be available for a tenant’s review, to understand how the cost per ft. is arrived at. It is typically done annually on a projected basis, and then reconciled at year’s end, to the actual expenses incurred on the property. Sounds like a lot of math and accounting - but it should be relatively straightforward and confirms the additional rental costs that apply.

Just a final note, on ensuring additional rent costs do not exceed your expectations during the term of the lease - there is a means of capping increases allowable on additional rent, so that a tenant is not faced with a 10-20% increase from one year to the next. It is acceptable to require a landlord to hold the line on annual increases to a modest % (say 2-3%), in any given year. The only justifiable exceptions would be for property taxes and or utilities, which the landlord has no real control over.

Again seek out experienced commercial realtors with strong leasing backgrounds, to assist you in negotiating the appropriate lease terms for your purposes.

Tuesday, November 15, 2011

Lease Base Rates

Next segment in our Leasing Series…Lease Base Rates.

When considering ‘Base Rates’ on a lease, this figure represents the dollars per ft. being paid for the premises. In industry terminology, this figure is normally considered to be ‘Net Rent’ to the landlord – which excludes all property taxes, operating, and common costs relating to the building. This is generally referred to as ‘Additional Rent’. The Net Rent is the basis of the return being generated on the property from an investment standpoint, and also serves to pay the financing against the property.

From a Tenant’s perspective, although base rates represent a major part of your monthly lease cost, you need to do the math in adding the additional rent portion (if this is confusing, look for our next post on Additional Rent). Typically, leased premises online are quoted at its base rate. As an initial comparison of properties, it is a good starting point.

In evaluating any market, you can typically seek out the base rate range of any district by looking at the active properties available. Getting to the actual base rates paid on recent deals, is a more involved process, but certainly is available if you look in the right places. These places include – MLS (ICX) data, local appraisers, and experienced local commercial leasing brokers.

As final note, what can you expect in terms of base rate fixing for a set lease term? Again things vary market to market and deal to deal – but generally, landlord’s will look for some sort of incremental increase(s) over the term of a lease. It will largely depend on the market you are in - ie. high vacancy vs. low vacancy and your approach in negotiating the deal.

Again seek out experienced commercial realtors with strong leasing backgrounds, to assist you in negotiating the appropriate lease terms for your purposes.

Tuesday, November 8, 2011

Lease Terms

Next segment in our Leasing Series…Lease Terms.

Outside of the actual lease rate itself (meaning the $’s per ft.), defined lease terms are the next most important aspect of the deal for both tenant and landlord. It represents the commitment between the parties, for a set period of time for use of the premises.

Terms will generally vary from market to market, and even from property to property. Newly built developments, be they offices/retail plazas, or industrial buildings, are based on longer term commitments for the most part. Typically 10 years would be the standard, at least for an anchor type tenant - with say 5 year leases being available only to smaller scale tenants. Lease terms are also vital to the financing which landlords arrange on these new builds. Generally landlord’s use the 5 year threshold as the bare minimum.

On existing buildings in most categories, term arrangements can become much more flexible. Start-up businesses often times prefer to stick with shorter commitments, as they are uncertain as to business volumes and growth plans in the early days. Bear in mind though, with 2 and 3 year commitments, landlords have little incentive to assist the tenant in any improvements which the space may require. Shorter term deals for the most part, would be done on an 'as is’ basis from the landlord’s side.

Just a quick note on renewal options (beyond the initial lease term). They are generally provided for on the tenant’s behalf, at a pre-set period in advance of the lease expiration (typically 3-6 months). This then gives the tenant the right to exercise his option to renew the lease, for a pre-determined period. In most instances the rental rate ($’s) , needs to be negotiated at the time of exercising the renewal option.

Again seek out experienced commercial realtors with strong leasing backgrounds, to assist you in negotiating the appropriate lease terms for your purposes.

Tuesday, November 1, 2011

Rent Free Periods

Next segment in our Leasing Series…Rent Free Periods.

Once we begin the process of strategizing proposed terms & conditions on a lease deal, what sort of rent free periods can we expect to obtain? As the saying goes – “as much as you can negotiate“.

But once we consider what might be considered reasonable from the Landlord’s position, you soon realize that there are a certain set of expectations which typically apply. Let’s look at the two scenarios below:

Example 1-
In a case where a tenant is proposing a reasonable term lease and accepting the premises in ‘as is’ condition, generally a landlord will provide a better rent-free
incentive. The rationale is that the tenant, in exchange for a rent-free allowance, will undertake their own tenant improvements at their own expense - thus saving the landlord any tenant improvement cost at the front end of the lease. It will vary deal to deal, but 3 months r/f on a 5 year deal should be reasonable - and assuming the tenant is investing their own funds to complete their improvements.

Example 2-
If the tenant has a requirement for the landlord to invest considerable dollars into tenant improvements on behalf of the tenant, then typically any sort of r/f allowance becomes a token amount. Although it can differ deal to
deal, generally a 30 day r/f might be the best case expectation – often times referred to as a fixturing period. In this scenario, the landlord has a further investment
into the lease and as a result, wants to realize the cash flow from the rent as early as possible after commencement.

Again seek out experienced commercial realtors with strong leasing backgrounds, to assist you in negotiating the rent free terms within your agreement.