In commercial real estate, the process of understanding the property, the terms of the lease, and the way your tenancy will work is called due diligence. Due diligence requires that you do your homework and pay attention to the physical, financial and legal aspect of the lease.
Without performing due diligence before leasing a property, business owners end up signing a lease that hampers their business operations. For instance, some landlords are unscrupulous and show no fair dealings when leasing a property. Many landlords lease out properties that are in the process of foreclosure, and some have very terrible relationships with their current tenants. Due diligence helps prospective commercial real estate tenants to avoid unnecessary conflicts and challenges when they move into their new office space.
In addition, due diligence helps tenants to know as much as about the property they want to lease as the landlord. This helps them to be in an advantageous position when negotiating with the property owner. Also, in the course of performing due diligence, business owners can find data that they can use in negotiating fairer deals.
Commercial Leasing Due Diligence Tips
A lack of due diligence before renting office space will save you unnecessary legal hassles and business disruptions. Hence, it is essential that you pay attention to the following due diligence tips:
Look out for Hidden Costs
Many commercial office leases make tenants pay for the maintenance costs. Hence, it is essential that you have a complete breakdown of the “gross lease,” so you know all the costs that you are responsible for. This will help in negotiating and also dropping the ones that do not fulfill your business needs. and also dropping the ones that do not fulfill your business needs.
If you signed up for any of the various types of net leases, you usually pay the base rent while the landlord pays for some or all of the other expenses. Landlords often have a template for their leases. Hence, it is essential that you review the lease options, so that you know what you are paying for. For instance, you can negotiate for higher rent in exchange for one of those running costs (such as insurance or utilities).
Evaluate the Terms of the Lease Agreement
It is essential that you know the terms of the lease agreement, especially in regards to default and termination of the lease. The knowledge of the termination clause will help in negotiating a fair penalty for lease termination before the time is up.
In addition to the lease termination, you can also identify the terms that will make you a responsible tenant. This will help in avoiding unnecessary conflicts that may hamper your business growth.
Assess Your Potential Future Growth
To avoid paying for extra spaces that you may never use, you should carefully assess your potential for future growth. Do not be overly ambitious, as this can result in having empty space that may never get occupied.
Hence, it is important that you list your company’s current and expected future needs before signing the lease. If you are uncertain about near-term needs, you should consider taking up a space that has enough usable square feet of office space per person for your immediate needs. This will help you to avoid accruing unnecessary expenses in unused space. You can negotiate with the landlord to give you options to extend your office size.
Research Market Rates
Obtain an idea of market rents in the area where you are considering and compare them with what the landlord is asking for the rent. It is also important to point out that just because you have lived in the same areas as the new property doesn’t mean the new rental rate will be in the same bracket. Hence, it is essential that you research the market rates and understand what the current trends are. Before you sign the lease and make a payment, it is essential that you get an idea of the average market rent in the area. This will help in negotiating a lower rate if your landlord is asking for a higher rate. When researching the market rates, you can talk to a broker who will give you updated information on the market lease rates.
In addition, you can use the best market comparable tools to figure out the rate per square foot dictated by the market.
Negotiate Tenant Improvements
Even though the commercial real estate market is considered a landlord’s market, tenants can still negotiate tenants’ improvements as they improve the long-term value of the landlord’s property.
When negotiating tenant improvements, here are a few things that you may want to pay attention to:
Ask for progress payments
This may be difficult to get, but you should ask for progress payments. This is because most lease clauses require the tenant to submit receipts for reimbursement after they have completed the entire project. This leads to a 90 to 120-day cash bottleneck. Hence, asking for progress payments allows you to receive reimbursements many times before the end of an expensive project.
Always get permits for your tenant improvements
Without permits, the landlord may not release the tenant improvement allowance. For instance, if you may a renovation work on a section of the building (such as demolition and construction of a wall), without a building permit, the landlord may not release the reimbursement.
Always ask for cash allowance first
Cash allowances and tenant improvements are the same except that there are no questions involved with cash allowances. In other words, you can choose to do anything with the cash. However, a tenant improvement allowance means that you have to improve the building with the money. In addition, with a tenant improvement allowance, you have to use your own money first before you are reimbursed.
When negotiating for build-outs, landlords often attempt to recoup their financial involvements through other lease terms like increases in expenses which are used in determining rental rates or passed through to the tenant.
Push For Grace Periods
Rent acceleration, lease termination, and enforcement costs (including court costs and attorneys’ fees) are some of the legal rights that landlords can enforce against defaulting tenants. As a potential tenant in a commercial office space, you should push for grace periods. In order words, push for the right to receive written notices of defaults and a reasonable opportunity to cure before a default is declared under the lease.
For the payment of rent, grace periods such as two five day grace periods during the term of the lease are common options that you can push for. For other defaults, you can request for at least 30 days of notice. This is even more important if you have a right of first refusal on another space that is terminated when you are in default under the lease. When pushing for grace periods, you may want to consider the following issues:
Certain leases require that you extend the term of your lease within a specified time window which is usually sixty to ninety days before the expiration of the current term. Hence, it is important that you note the date because these provisions are adhered strictly by the courts.
Some leases require that you lose these provisions if you have ever defaulted under the lease. Ensure you insist on a provision that allows you to exercise your right to extend the lease as long as there is no outstanding default.
Pushing for grace periods is a valuable approach for all tenants because if the term is nearing its end and there is no option to extend, the landlord has substantial bargaining power.
Have a Long-Term Lease Plan
Before starting the negotiation process, ensure that the term length in the lease matches your company’s business goals. If you run a start-up, you may want to see a shorter term lease with renewal or expansion rights. However, established organizations and traditional industries may want to go for a longer term in order to have stable cost metrics.
Landlords prefer tenants who sign longer term leases. Nevertheless, you should consider your commercial situation before adopting the lease term proposed by your landlord. If your business already has a stable foundation, a long term lease may be ideal for you. It helps you establish a fixed presence in the market without having to worry about an unexpected variation in the rental terms. Also, it helps you build a good reputation, especially when you have a fixed location. In addition, a long term lease allows you to plan the future as the details of your lease are already spelt out and are unlikely to change if the owners change.
It is important to know that having a long-term lease plan does not necessarily mean signing a long term lease. It means that even if you are signing a short term lease because you are just starting out or want the advantage of mobility, you should consider where you want to be in the long term. This will help you when negotiating the details of your clause whether short term or long term.
Consider the Renewal Options
The duration for a commercial office lease can range from month-to-month to several years. If you would like to occupy the same space, it is important that you understand the renewal options. When considering the renewal options, you should negotiate other options too—such as the right of first refusal to lease an adjourning space (in case you want to expand). Conversely, if the rental market has declined, the landlord might give you a better deal when you renew.
In addition, do not be shy in asking for tenant inducements. You will be surprised at what deals you may get. Office space could be vacant for months, and the landlord might be eager to offer one to two months of rent for free. Some may even agree to finance part of the office renovations.
The duration of your office lease can range from month-to-month to several years. Hence, it is important to ensure that you know your renewal options.
Check Local Laws
When conducting your due diligence, it is unsafe to assume anything. Do not assume that your landlord is up to date on local zoning laws and regulations. If you do not conduct due diligence on your potential landlord’s compliance with local regulations, it may hurt your business. Many companies have been put out of business due to the landlord’s negligence.
Therefore, it is important to check local zoning laws to determine what restrictions they have. All commercial real estate has local commercial property zoning requirements. Zoning laws determine the type of business that you can operate in a building. For instance, a warehouse is a commercial property zoned for industrial use. When checking the local zoning laws, contact the local chamber of commerce. Also, you can do a simple Google search for the local zoning regulations.
Conduct a Background Check
Before signing the lease ensure that you conduct a background check on the landlord and property management team. You can do this by checking online reviews as well as news articles. This will help you to know what other companies think about the landlord and the location.
You can contact the local agencies to confirm if the landlord is the actual owner of the space and is authorized to lease it out. This is necessary because some properties are in the foreclosure process. Properties in the foreclosure process do not belong to the landlord anymore. In addition, you may want to check if the landlord has any criminal records. These records can include a history of frauds, rent agreement violations, fights or criminal records. Even though most criminal courts will offer all the assistance you need to check the criminal records, it is advisable to start with a basic search on the internet. This will help you to screen out bad landlords early on in your leasing process.
Finally, ask questions. Here are a few questions you may want to consider when conducting a background check:
Where does the landlord stay?
Are there any restrictions on late entry?
Who should bear the repair expenses?
Is there a guest policy?
What are the move-in and move-out processes?
Is parking facility free or chargeable?
Are pets allowed?
You may the assistance of a tenant rep when conducting a background check. Most tenant reps have years of experience in the commercial real estate industry and know most landlords in the area, so they must have carried out a background check on the landlord and the property in the past.
Understand the Space
Finding and leasing commercial office space that fits your budget and meets your needs can be both exciting and stressful for business owners. With so much to consider when you're comparing potential office spaces, it's easy for something important to slip through the cracks. Following these tips will help to ensure that you don't overlook an important detail.
Explore All of the Areas You'll Be Paying to Rent
In addition to paying rent for the square footage in your office space, your lease will require you to pay Common Area Maintenance to cover costs associated with the shared spaces in the building. Take the time to walk through the lobby, hallways, reception rooms and other common areas. Think about how well they are maintained and what sort of impression they will make both on your team and any possible visitors.
Introduce Yourself to the Neighbors
Stop into the offices located on your floor or the floors directly above and below you. Introduce yourself to key decision makers and ask for their impressions of the building. Doing so will give you a feel for the type of environment you'll be working in and an idea of the landlord's reputation. Some landlords have a reputation for engaging in unscrupulous activities like neglecting required repairs and exaggerating actual square footage. To avoid future conflicts with the landlord which may affect your business operation, it is essential to introduce yourself to the neighbors and learn more about the landlord.
Your neighbors can also affect your business. Hence, it is important that you know who they are and their respective business practices. You also want to figure out how long they have been there. Ideally, you will not have a direct competitor in the same building.
Ask About Amenities
Another factor to consider when you are understanding the space is asking about the amenities. The nearby amenities can have a huge impact on your office space.
More and more office buildings are offering amenities to attract prestigious tenants. Find out if the one you are considering has an on-site fitness center, a restaurant or cafeteria or other perks. It's important to realistically evaluate the value of any available amenities. For example, if your employees start their days early and leave at 4 PM, a fitness center that is locked until after 5 PM won't be of much use. In addition, your team will prefer an office that is close to restaurants and coffee shops. Also, you want certain places that you visit regularly for business purposes, such as banks and meeting spaces, to be as nearby as possible.
Browse the Directory
Familiarize yourself with the complete tenant listing for the building. Are there any competitors renting space inside? Do you notice any companies that you would prefer not to be associated with due to their reputations or business practices? Do the tenants seem to be all of one type? As an example, a tech company may not want to be located in a professional building that is exclusively home to medical and dental practices.
See What It's Like to Arrive and Depart at Key Times
Visit the building at the times when your employees start and end their days. See how long it takes to find parking and to reach the office. You may find out that the number of elevators leads to delays in entering or exiting or that parking spaces are not adequate.
Walk the Neighborhood
The location of your building can have a big impact on employees' work-life balance. Stroll the streets that surround the building.
Would you feel safe walking there alone after dark?
Are there dry cleaners, pharmacies, salons and banks conveniently located nearby?
Will your employees be able to find places to have lunch or to stop off for drinks after work?
Buildings located in questionable neighborhoods or in remote areas with few other businesses could pose problems for your team.
Surf the Web
Find out what people are saying about the building and the landlord online. A quick Internet search could reveal information about past lawsuits, accidents related to safety concerns or unscrupulous business practices. It is advisable that you spend as much time online to get accurate information about the building and the landlord. Some landlords pay search engine optimization experts to clean their online footprint and rank only positive reviews online. By digging deep and checking the second page of the search results, you may uncover some information about the landlord and the property that otherwise you would have missed.
Things You Might Not Have Considered In Your Commercial Lease
There are many things that many corporate real estate tenants might not have considered in a commercial lease. Once you have decided to go ahead with the lease, there are certain things that you want to ensure are clearly defined. In this section, we are going to explore these things, so your lease agreement does not hamper your business activities in the future.
Clearly Defined Premises
Many leases are not clear as to exactly what you are renting. Make sure that your lease clearly defines your space, its size, and whether the size is on a rentable or usable basis. If your lease refers only to your usable space, research who pays for the loss factor. Keep an eye on the detail and discuss every aspect of the lease. Most clauses in the lease agreement are negotiable, so it is essential that you check that you are signing a lease that offers you exactly what you want. Hiring a broker may be helpful in clearly defining the premises.
Reasonable Insurance Requirements
While it's completely reasonable for a lease to require tenants to carry insurance to protect themselves and the owner of the property, some landlords insert unreasonable lease terms to require tenants to buy very high levels of insurance coverage. Some insurance requirements are common; they include property damage and liability coverage. Others, such as loss of rent, are more specific to leased space.
Review the lease carefully and if it asks your business to take out an unreasonable level of insurance, do what you can to renegotiate it. The insurance clause in the lease specifies who is responsible to pay for the required coverage. Generally, in a full service or gross lease, it is the landlord who is responsible for all the expenses of running the building, including insurance.
However, in triple net leases, the tenant is responsible for their share of every expense, including the landlord's and tenant's insurance policies. You can negotiate the leases that fall in between the two gross lease and the triple net leases.
Option Terms & Notification Periods
Renewal options can be tenant-friendly, but the way that they are drafted can change this very quickly. Ideally, your options should be under your control, meaning that you should have to notify your landlord to renew your space, as opposed to having cancellation options wherein your lease is automatically renewed unless you request otherwise. Also, make sure that the lease terms defining the execution date for your options are clear so that you don't miss out on being able to take advantage of your options.
In addition, the lease should clearly indicate how the rent will increase: when and how. Also, the lease should clearly indicate the tenant’s rights with respect to an increase in the monthly rent. This will help you in deciding on the tenure of the lease and planning out other expenses in advance.
Subletting & Assignment Clauses
Most landlords want their tenants to stay in their buildings for their entire lease term. However, given the fluidity of business, you might find that you need to vacate a space early because you no longer need it or because you outgrow it. Review the lease terms carefully to ensure that you have permission to either sublease your space or assign your lease to another tenant.
Ideally, you will want the lease to include a sublet and assignment clause. This allows you to allow another tenant to use part or all of the space before your lease term ends. It is important to point out that a sublet or assignment clause does not relieve you of some or all your responsibilities under your own lease. If the subtenant fails to pay for the rent or other lease obligations such as damages, you will still be responsible for paying the rent.
When you sign a lease, you enter into a business relationship with your landlord. If they do something that lands them in legal trouble, you could also get dragged into it, and the same could happen to them if you have an issue. It's completely reasonable for your landlord to insert lease terms that have you indemnify them against anything that you do for which they could be held liable. However, if you're going to indemnify them, they should also indemnify you. This indemnification will typically come in the form on non-disturbance agreements, and similar clauses.
If your commercial lease agreement contains a break clause, either you or your landlord may seek to terminate the lease before its fixed period has ended. Not all commercial leases will include an early termination clause. Hence, it is important that you consider if you want it before signing the lease document. This is because terminating a lease untimely without an early termination clause may incur a severe lawsuit.
Including early termination clauses in your lease that specify when you or your landlord can terminate the lease can be a good idea. However, some termination clauses can be very harmful to your interests. For instance, if a landlord inserts a "Termination for Convenience" provision in the lease, they could move your business out of their building under seemingly unreasonable circumstances.
Nevertheless, there are good reasons to end a commercial lease early:
The commercial space no longer meets your business needs.
You wish to end your business and move on to other things.
Changes in the market.
It is important to note that it is very hard to get a landlord to sign an early termination clause, especially if you are signing a short term lease. When reviewing the lease agreement, here are a few questions you may want to ask:
What are the damages, if any, for ending a lease early?
Can the landlord assign the lease to a new tenant if the agreement ends early?
Does the lease include a recapture clause?
A holdover occurs when you stay in your space beyond your lease's termination date. If you don't have lease terms that specify what happens if you need to overstay your lease, you'll be at your landlord's mercy, likely paying as much as double or triple the rent of your last payment within the lease. If your lease doesn't have a holdover clause, work with your landlord to insert one that specifies terms that both you and he find acceptable.
4 Ways to Get a Better Office Lease
When you're searching for space and negotiating an office lease, there are some factors that are beyond your control. While you can't control market trends and occupancy rates that affect costs, there are steps that you can take to get a better lease. Following these five tips can help you secure a lease in a desirable space more affordable and ensure that you get the best possible deal.
1. Start as Early as You Can
Many businesses underestimate just how long it can take to find the perfect space and negotiate a fair deal, and this can be a very costly mistake. Start your hunt for the ideal office as early as you can. This way, you won't feel pressured to settle for a space that does not fully meet your needs or to sign a lease with less than favorable terms.
2. Create Competition
Although you may have a favorite space in mind, don't narrow down your options to just one office. Start negotiating with more than one landlord, so that you can leverage deals against one another. In areas where office space is plentiful, you can often secure concessions, lower rates and favorable terms by forcing landlords to compete. Plus, if the deal falls through with your number one choice, you'll have a backup at the ready, and won't find yourself back at square one.
3. Leave Room for Flexibility
When you're negotiating your office space, make sure that your lease agreement gives you some flexibility. Having a cancellation option that allows you to exit the lease by paying a fee or including subleasing and assignment rights can help to ensure that you're not stuck in your location or with tons of unused office space. Also, make sure that you have the right to renew your space at the end of the lease term before it's offered to the general public. Flexibility in your lease agreement allows you to run your business without much hindrances.
4. Don't Go It Alone
One of the easiest ways to get a better lease agreement is to enlist the help of a tenant representative broker at the start of the search process. Tenant reps know the market inside and out and can use their knowledge to help you negotiate the best possible lease. Plus, tenant rep brokers will be able to match your company's needs with the right offices, ensuring that you're satisfied with the space that you select. Although a tenant rep broker's services are invaluable, having one on your team won't cost you a penny as the broker's fees are paid for by the landlord after the lease is signed.
Renting commercial space can be a huge dive into a minefield of hidden costs. To avoid making decisions that may hamper your business process in the future, it is advisable that you conduct your due diligence. The commercial real estate field is full of landlords who have years of expertise in the industry. Hence, they can be very aggressive, especially when negotiating with new business owners. Therefore, it is important that you start conducting your due diligence long before you meet the landlord.
Due diligence when renting an office space is very important. It will save you unnecessary stress and help you to avoid distractions which may affect your business flow.
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