Real Estate & Related Terms Explained: First Right of Refusal

As  we wrap up this series on leasing terms for the year, another confusing term/subject is on deck.  Although the definition is pretty literal, the application of it in the commercial leasing world isn’t so straightforward.

What Exactly Is A First Right of Refusal (FROR)?

A right of first refusal is a contractual right of an entity to be given the opportunity to enter into a business transaction with a person or company before anyone else can. If the entity with the first right of refusal declines to enter into a transaction, the owner of the asset is free to open the bidding up to other interested parties.  In the real estate world, this business transaction refers to the real estate premises in subject, be it commercial space, land, etc.

When Would A First Right of Refusal Apply?

The most common time when you see a first right of refusal applicable would be when a tenant is leasing a space, the landlord decides to sell, and the tenant has a first right of refusal to purchase the property.  Another common application would be when a tenant in a building is growing and as a neighbouring space becomes vacant, the tenant would have a first right of refusal to lease the additional space before the landlord can lease it to another tenant.

What Else Should I Know About A First Right of Refusal?

A first right of refusal is a term of a lease agreement that should be negotiated along with other terms at time of lease negotiations.  It usually states a date that relates to the first right and the mechanism for administering it.  The more thoroughly stated the better, so there are no disagreements later.  

To use an example: if a tenant has a first right of refusal on the building they occupy that states that should the landlord get a bonafide offer to purchase from a third party, the tenant will have seven days to match the terms of that offer.

The actual clause in the lease agreement will be more detailed but that covers the basis of it.

Obviously, a first right of refusal is a benefit to a tenant if they desire to own the building they are in someday.  It is a nice perk.  It is also a benefit to have a first right on neighbouring space, as being able to expand without moving is attractive.

On the landlord’s side, it is sometimes a detriment to have a first right of refusal when selling their building.  If a third party buyer knows that the tenant has a first right of refusal to match their offer, they might decide to not bother.  It really depends on the situation though.

As always, make sure to hire an experienced commercial realtor to negotiate terms in your lease, including first right of refusals!  Once again, this wraps up our series on explaining leasing terms for the year.  Hope it was informative.  If you ever have questions don’t hesitate to drop us a line.

Real Estate & Related Terms Explained: Personal Guarantee

Let’s say you are an aspiring entrepreneur and you have an idea for a small business. You work on your business plan, get approved for some financing at the bank and as everything looks promising, you are ready to start looking for commercial space. After your commercial realtor finds you the perfect space, you negotiate a deal with agreeable terms but one issue has come up that you didn’t foresee – a personal guarantee.  Today we are going to discuss personal guarantees.

What is a Personal Guarantee/Indemnity?

A personal guarantee (also often referred to as an indemnity), is really exactly what it sounds like – an unsecured written promise from an individual to repay any obligations of a business. So in the above case, should your business not go as planned and you decide to close down, you will be personally liable for the lease obligation remaining. When we say the guarantee is unsecured, we mean that your guarantee is not tied to a specific asset (ie your home) but in the event of default the landlord could go after any of your assets to settle the debts.

Why Would a Landlord Want a Personal Guarantee?

A personal guarantee is essentially an extra level of security for the Landlord. These are especially prevalent and common when doing leases with small businesses. Small businesses generally have less in the way of assets and therefore the financial health and creditworthiness is tied to the owner’s personal finances.

Take the example of a new startup business with zero in assets and the landlord who is agreeing to renovate the space on the behalf of the tenant for their needs. There is high risk of failure in this situation, and as such it is prudent for the landlord to request a personal guarantee. It should also be noted that in the above example, when the tenant was approved for financing from the bank, this would’ve come with personal guarantees at the bank without a doubt!

Once a business is established with assets and a history of profits, the needs for a personal guarantee is lessened. At that point, a landlord and likely the lender as well will look to the financial health and creditworthiness of the corporation. A personal guarantee is also less necessary in certain other situations, like when a tenant is renovating their own space or if the term is short enough to not have it worthwhile.

What Else Should I Know About Personal Guarantees?

The issue of personal guarantees is a term that should be discussed as part of an offer to lease. That way there are no surprises when the lease draft comes out. A personal guarantee can also be offered by a third party. Take the example of a young professional with limited assets or credit history and their parent agreeing to personally guarantee their lease. Lastly, a personal guarantee can be negotiated for a period of time (ie say you signed a 10 year lease, but only agreed to a personal guarantee for the first 5 years).

Make sure if a personal guarantee is applicable to your lease deal that your commercial realtor negotiates the terms on your behalf. And also make sure your lawyer signs off on the clause or related indemnity agreement in your lease. In the (hopefully unlikely) event that it becomes an issue, you’ll be glad you did.

Real Estate & Related Terms Explained: Sublet

You may have heard the term sublet or sublease before, as in “my friend is subletting their space”.  But do you know what that means?  This is an important topic as a Tenant or Landlord in commercial leasing and one that is rarely understood properly, until the situation arises…

What Exactly Is a Sublet?

A sublet occurs when a Tenant no longer needs their space or it no longer suits their needs, but still is responsible for the remainder of the term of the lease they signed. So, instead of letting the space sit dark while continuing to pay, they sublet the space to another Tenant. When some sort of arrangement is agreed to, a sublease agreement is signed by both parties.

How Does a Sublet Work?

After a sublease is signed, the sub-tenant starts to pay rent to the sub-landlord. The Tenant in turn continues to pay rent to the Landlord. Even though the sub-tenant is now occupying the space, the original Tenant is responsible for all the terms under the original lease.

What Else Should I Know About Subletting?

If a Tenant wants to sublet their space, they require a Landlord’s written approval. Landlord’s are not allowed to unreasonably refuse a request for a sublet. Usually your lease agreement will speak to the ability to sublet and any mechanisms that apply. Should you have any issues with subletting, contact your lawyer.

From a sub-tenant perspective, sometimes subleasing space comes with risk, as it doesn’t come with any renewal options. This can put you in a bind when your term runs out. Therefore, when we have strong Tenants considering a sublet space, often times the deal goes back to the Landlord for them to deal with directly (instead of on a sublet basis) on the space so that proper terms can be negotiated for the tenant and then a termination is negotiated between the Landlord and the existing Tenant.

With careful thought and planning, sublets can be pulled off without a hitch. Make sure to hire an experienced commercial realtor to guide you through the process towards a smooth transaction.

Real Estate & Related Terms Explained: Renewal Option

Say you are a commercial tenant in a plaza and business is pretty good. You are established now and planning for the future. Before you know it, a few years have gone by and you realize that your lease must be coming up for renewal later this year. But do you really understand what a renewal option is and what rights and obligations you have? Today we are going to discuss the important topic of renewal options.  

What Exactly Is A Renewal Option?

A renewal option is a clause within your lease that outlines the terms for renewing or extending a lease agreement. Obviously this renewal option comes into play as you approach the end of your lease term.  These renewal options are at the right of the tenant and not an obligation.

How Do Renewal Options Work?

Renewal options generally spell out how (usually in writing to the Landlord), and when (usually a time period before the expiration of the lease, ie 6 months), this option can be exercised. There is also usually a number of renewal options (ie. 3 options of renewal), and a lease term (ie. 5 years), tied to a renewal option. This also assumes the Tenant is in good standing not in default of any of the covenants of the lease. The wording of your renewal option will be a clause included in your lease agreement.  Make sure to have your lawyer read over the clause to protect your interests.

What Else Should I Know About Renewal Options?

Sometimes renewals also spell out the rental rate. The rest of the time the rate in the renewal is at “a rate to be negotiated”. This rate to be negotiated is supposed to be at a market rate at the time of the renewal. In Ontario (our market where we practice real estate), in the case where a Landlord and Tenant can’t come to terms on a rate, there is an arbitration process to resolve the matter.

In the event a Tenant doesn’t exercise their right to renew, they end up holding over month to month and lose all additional renewal options. If you’d like to read up on this situation, be sure to read our blog on this topic here.

Renewal options are a negotiating term when negotiating a commercial lease. Make sure you get a good commercial realtor to negotiate your renewal options on your behalf and be sure to understand this renewal option for the future.

Real Estate & Related Terms Explained: Month to Month

In your business travels, you may have come across a Tenant or Landlord that is leasing a space month to month. But do you know exactly what that means and what the ramifications are for both parties? Today we are going to explain month to month tenancies.

On a side note: Our discussion will be in regards to commercial leasing month to month. Residential month to month tenancies is another topic and can get very technical depending on your jurisdiction (ours being Ontario). Read up on your residential Landlord-Tenant laws to learn more about residential month to month tenancies.

What Exactly is a Month to Month Tenancy?

A month to month tenancy is technically a lease arrangement that is terminable by either party on 30 days notice (hence the term month to month). This terminable aspect of the lease goes both ways, for both the Tenant and the Landlord.

Why Would I Find Myself In A Month to Month Tenancy?

You could have entered into a month to month tenancy at the beginning of a lease, either as a Landlord or Tenant, by agreeing to not have a lease term (ie. 1 year) attached to your tenancy. The other way you could be involved in a month to month tenancy, is when the Tenant’s lease term is up and is either out of options to extend, or has decided to not exercise their right to extend, and is therefore holding over on their lease month to month.

What Are the Pros to a Month to Month Lease?

The pros of a month to month tenancy as a Tenant are obviously that should things turn sour in your business, you could close down in 30 days and not be on the hook for a long lease term. Or, if you are a tenant looking for a better location or space for your business, holding over month to month allows you to continue to operate while searching out new premises. The pros for the Landlord would be that it creates flexibility should a long tenant user come along to take the existing tenants space, or if you had a multi-unit building and needed to accommodate a larger user tenant.

What Are The Cons to a Month to Month Lease?

Obviously the con to a month to month tenancy is a lack of security both ways. As a Tenant if you are holding over month to month, the Landlord could at any time lease the space to someone else with 30 days notice. Likewise for the Landlord you could have any empty unit with only 30 days notice to prepare. Also as a Landlord, month to month tenancies will make it harder to finance and sell for proper value.

As always your lease agreement will have clauses in it relating to this topic. Make sure you understand those clauses and how they relate to your situation. If you have a question about your month to month tenancy, feel free to drop us a line!

Real Estate & Related Terms Explained: Tenant Improvements

Continuing on in our series of explaining real estate and related terms, now that you understand the types of commercial leases we are going to touch on some terms you will often come across. Today we are going to be talking about a subject that many potential tenants find confusing: Tenant Improvements.

What are Tenant Improvements?

Tenant Improvements are alterations made to a commercial or industrial premises in order to customize it for the specific need of a tenant. Examples of Tenant Improvements would include walls, flooring, ceilings, lighting, kitchens, paint, etc. Many people in the industry use the short form "T.I.s" when referring to Tenant Improvements.

Who Pays for the Tenant Improvements?

Every situation is different and often it depends on what you are able to negotiate. On one end of the spectrum the Tenant pays for all their own tenant improvements. On the other end the Landlord pays for all the Tenant Improvements (often referred to as a “turn-key”). Often they meet somewhere in the middle. Landlords will sometimes quote a base rent that includes a Tenant improvement allowance built in when leasing over a long term ($15/ft base rent, includes a $25/ft Tenant Improvements allowance on a 10 year term).

What Else Should I Know About Tenant Improvements?

Often times as a Tenant you can make your best deal taking the space as-is and pay for the Tenant improvements yourself. This better deal can result in lower rent over the long term and generous rent free periods at the beginning of the lease. On the flip side, it's possible as a Tenant that you don’t have the capital to fund all your own Tenant improvements or don’t have the time or skill to manage the project.

As a Landlord, there are also pros and cons to participating in the cost of Tenant Improvements. The pros include you can usually command a higher rent and longer terms. This can make your rent roll look good and increase the potential sale price should you plan to sell in the near future. The cons are obviously that you need to come up with the capital and also that you need to be sure to qualify the Tenant and their creditworthiness. Essentially, you're loaning them the money for Tenant Improvements that you will recoup over the term of the lease.

With the cost of construction increasing all over the place, it's important to factor in Tenant Improvement costs and who will be responsible for paying what. A knowledgeable commercial real estate specialist should be able to educate you on the dynamics of your market and how best to position yourself.

Real Estate & Related Terms Explained: Gross Lease

 As we continue on in our series of explaining real estate related terms, the streak of leasing-related topics continues. Over the last few weeks we have discussed triple net leasing and some related terms. Today we are going to touch on the opposite end of the spectrum when it comes to leasing… gross leasing.

What Is A Gross Lease?

A gross lease is a type of lease where the Landlord pays for the building’s operating costs, including the property taxes, insurance, maintenance, etc. From the Tenant’s perspective this equates to a flat fee or monthly rent in exchange for using the space. This is the opposite of how a triple net lease is administered, where the Tenant pays their proportionate share of the building’s operating cost.

How Is A Gross Lease Administered?

A gross lease is either administered as $/ft figure (ie $10.00/ft), or as a flat dollar amount per month ($2000/Month). Obviously from a Tenant’s perspective, a gross lease is simpler as the cost every month is fixed. Naturally, some Tenants prefer this type of lease arrangement, compared to triple net leasing.

What Else Should I Know About Gross Leasing?

Gross leases can sometimes include utilities cost and sometimes they are separately metered. It is important to understand how utilities are charged in the gross lease deals you are looking at. As a Tenant in a gross lease building, even though you aren’t paying additional rent to cover your share of operating costs, you will want to also ensure that the maintenance of the property has been kept up (landscaping, snow removal, etc). This can be done with language speaking to this in your lease agreement.

Sometimes you will run across a building that is run somewhere between a net and gross lease arrangement. These can be referred to as semi-net or semi-gross leases with an adjustment for part of the operating cost (ie. property taxes or utilities). The Landlord will set up a gross lease, but charge you back for your share of utilities or property taxes. Your lease agreement should speak to any special arrangements like this.

On the Landlord side generally lenders and other investors won’t view investment properties with gross leases as favourably. As opposed to net leasing where the Landlord is collecting a net rent yearly, with gross leases the Landlord is responsible for the expenses. This can lead to variability in the net income of the property and therefore leads to a lower applicable cap rate (valuation) when selling or financing the property.

Now you know the difference between a gross and a net lease. If any of these concepts are still confusing for you, feel free to drop us a line. We are here to help!

Real Estate & Related Terms Explained: CAM

Next up in our series on explaining real estate and related terms is another about commercial leasing. The term is actually an acronym and the concept ties into additional rent, which we discussed last week.

What is CAM?

CAM stands for common area maintenance. CAM comes into play in a multi-unit property where tenants share a common area(s). This common area can include common hallways, elevators, parking lot, landscaping area, utility rooms, common restrooms, and more.

How are CAM charges administered?

CAM charges are usually administered as part of the additional rent. Each tenant pays their proportionate share of the common area maintenance charges. Generally they come up with a figure per sq ft (ie. $2.00/ft, which would be the tenant’s share of common area maintenance for the year).  This budgeted CAM cost is usually billed monthly based on the budget and then reconciled with actual expenses at year end.

What else should I know about CAM?

CAM charges are sometimes advertised totalled with property taxes to give you a total additional rent figure. Sometimes they are advertised separate where they disclose a property tax number, plus a CAM number (ie. $5.00/ft for taxes and $2.00/ft for CAM total $7.00/ft additional rent). Certain types of properties will have higher CAM costs than others. A 20 storey office tower with several elevators and lots of common hallways and facilities will have higher maintenance costs than a small strip plaza with minimal parking and no common entrances or hallways. Sometimes CAM can also include a management or administrative cost to administer the bookkeeping of the common area maintenance and additional rent. This should be apparent when viewing the operating cost budget.

CAMs are another confusing topic for many people. Its important to understand what common areas you are responsible for as a tenant, what the maintenance of these areas is costing you, and what you are getting for those charges. Don’t be afraid to ask questions!

Real Estate & Related Terms Explained: Additional Rent

Last week to kick off our new series, we discussed a term related to commercial leasing (one of our specialities), triple net. Unfortunately, there are many confusing and interchangeable terms used in commercial leasing. Today we are going to explain additional rent, so you understand the breakdown of your rent payment every month.

What is Additional Rent?

The technical definition of additional rent is "any rent in addition to the base rent payable by the tenant". So this additional rent, in a triple net lease, would usually include the tenant’s share of the costs of the property, including property taxes, insurance, snow removal, repairs, and more.

What Else Should I Know About Additional Rent?

Additional rent is usually quoted as a dollar amount per sq ft (ie $7.00/ft). In our market, there is a field on MLS where you can input the additional rent figure for each commercial lease listing. That way you know what your total rent will be as a tenant. Add the additional rent figure to the base rent and multiply it by the square footage to get your total annual rent. Divide that number by 12 to get your monthly rent total. You should also know that additional rent is usually a budgeted number and it will be reconciled with the landlord every year depending on the actual operating costs of the plaza.

Why Does This Additional Rent Figure Vary By Property?

The additional rent will vary by property because the operating cost of each property is different.  One property could have a higher assessment value than another and therefore their property taxes are higher. Or if there are more common areas in a building, the utilities and maintenance cost of this space will add to the additional rent.  

If you see a property with an extremely low number, that can be a red flag that they are under estimating the operating costs and you will most likely see them increase substantially over the budget. Another general observation you can make about additional rent is that the newer the property is, the lower the repairs and maintenance costs generally are, therefore the lower the additional rent figure will be. The opposite is generally true of older buildings.

Additional rent is a confusing topic, so don’t be afraid to ask an expert. If you have any questions about additional rent in your situation, feel free to email us anytime ☺.