Three Things to Keep in Mind with Your Commercial Lease

Scott Price | August 24, 2016

Client signing a real estate contract in real estate agency

Rent is only the beginning when it comes to negotiating a commercial lease. A multitude of provisions can add to that amount significantly, so it pays to be prepared. Not only is it important that you know the average cost of the type of commercial space you’re seeking—retail, office or industrial – you also need to have a good idea of expenses you want to have covered, and industry norms. Before viewing properties, make a list of questions and always get terms in writing. Remember, each term can have financial consequences that add to your annual expenses and impact your company’s bottom line.

1. Commercial Rent versus Effective Rent

The most visible and negotiated provision will be the rent rate and increases over the lease term. It’s important to keep in mind that a rent rate is just the beginning when it comes to the actual cost of the occupancy or the effective rent. The effective rent is the adjusted amount after concessions or improvement allowances are factored in, and allows a more apples-to-apples comparison for different properties. Most landlords will insist on escalations, and like all other terms, those escalations are negotiable and can vary by market based on norms. For example, some markets see a $0.25 or $0.50 per square foot increase in base rental rate annually, while for others it may be a percentage or a published rate.

The important thing to remember is that you need to consider your effective rent versus the market effective rent to make sure you are within market norms. A broker that specializes in commercial real estate will have a strong understanding of the competing comparable leases and their market terms, as well as concessions, capital or tenant improvement allowances, etc. This information is valuable for you, especially in the initial leasing and space planning process, and broker expertise can help you capture a better effective rent and stay true to your company’s priorities and budget.

2. Base Year, Expense Stop, and Escalations

Full service commercial leases include what is called an expense stop, base year expense stop, or sometimes stop clause. The base year is the year for which operating expenses over the term of your lease are measured and usually cover the first full year of your lease. Expenses that go above and beyond the base year amount are charged back to the tenant as an escalation. For example, if your base expenses are $10.00 per square foot and then go up to $10.50 per square foot the following year, the extra $0.50 per square foot can be charged to you as additional rent. This provision is put in place to minimize the landlord’s risk, but can also benefit the tenant if the landlord appeals the property tax or reduces utilities through audits, etc.

Depending on the lease structure, the landlord may be able to install capital improvements to the building and recover those costs by amortizing them into the building expenses. Some capital improvements like HVAC automation may save substantially on operating costs and be considered recoverable, whereas cosmetic enhancements or common elements like roofs or parking structures should be part of the landlord’s capital cost. Other costs that may be charged back to the tenant above the base year cost could include government requirements (such as sprinklers) imposed after the commencement of the lease. It’s important to be seek professional advice where these provisions are concerned, and realize that these costs can fluctuate based on regulations and market conditions.

3. Tenant Improvement (TI) Allowances

Tenant improvement, or TI allowances are probably one of the most misunderstood provisions of the average office lease. Office space is the most capital intensive type of commercial space for landlords to build out, and the capital requirements must be carefully modeled and built into their investment model. In today’s commercial environment, using the landlord’s capital to finance your office space can be a smart move if handled correctly. A key consideration in negotiating your TI allowance is ownership of the improvements going into your space.  In the battle for talent, many firms are investing in glass office front systems, elaborate café fixtures and equipment, specialty lighting and creative zones and collaboration areas.

Most leases haven’t kept pace with these shifts in tenant investment. If you invest a significant amount in your space, when your renewal term arrives you could find yourself at a disadvantage when it comes to negotiating since the default lease terms allow the landlord to own everything affixed to the space. You need to realize realize that as a tenant, you are ultimately financing one way or another, whether buying, leasing, paying cash for improvements or amortizing them into the lease rate. That’s why it’s important that you get help to structure the lease when planning your space, and negotiate terms that shift the balance in your favor.

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Rent is only part of the financial consideration when it comes to your next commercial lease, and that’s why it makes sense to have someone working with you, and for you, throughout the lease negotiation process. At PlaceValue, we are standing by to help you get the lease and the space that will meet your needs now and in the years to come. As a leading independent planning, procurement and project management firm, PlaceValue helps our clients realize today’s high performance, adaptable work place, objectively and without bias. By aligning business workplace design with business strategy, managing the supply chain for maximum value, integrating project delivery, and leveraging our buying clout, we bring our clients immediate cost savings and long-term return on workplace investment. Our independence, world class process and pricing transparency, ensure the best possible outcome for your new workspace. Call us to schedule your free consultation today.

If you’d like to read more about leases, and the hidden landmines and pitfalls to look out for, download our free report Top 10 Things to Consider when Leasing Commercial Office Space

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