Monthly Archives: December 2021

Understanding Your Commercial Lease Agreement

Commercial Lease Agreement

You will come across many clauses in your commercial lease agreement that have been prepared by the Landlord. There is more to consider than just price, rent abatement and tenant improvement allowance (TIA) including security deposit requirements restrictions on how you use the property, and who will pay for maintenance of the property and capital improvement. Before you actually engage a landlord to start negotiate a lease you’ll want to write down your “Nonnegotiable items”

• Amount of the rent. Know what your rent includes and does not include. There are different costs absorbed and assigned by the tenant and landlord depending if you are in a Triple Net (NNN) lease, Modified Gross lease or Full Service lease. For example in a triple net lease you will be responsible on a pro-rata basis the taxes, insurance, and maintenance above the base rent in most cases this can be between $4.00-$7.00 PSF.
• Size of the space you need. knowing the difference between usable and rentable square feet and how the landlord measures this. If you’re going to pay all or part of the landlord’s real property taxes, its important that the commercial lease agreement specify that you’ll pay according to your percentage of the property’s total rentable space.

Usable square footage

Is the actual space you occupy from wall to wall. Usable square footage does not include common areas of a building such as lobbies, restrooms, stairwells, storage rooms, and shared hallways. For tenants leasing an entire floor or several floors, the usable square footage would include the hallways and restrooms exclusively serving their floor(s)

Rentable square footage

is your usable square footage PLUS a portion of the building’s shared space. As mentioned above, shared space can be anything that is outside of your occupied space and is of benefit to you (lobbies, restrooms, hallways, etc). As a tenant in a commercial space, you pay for a portion of the shared space and thus your monthly rent is always calculated on RSF.

Calculating the load factor is pretty straightforward. First, find out how much total floor area a building has then subtract the shared square footage to determine the usable square footage. The owner or owner’s agent should be able to give you these numbers. Then divide the total floor space by the USF to get the load factor.

If you pay according to the total space that happens to be rented at the time, you can end up paying an enormous portion of the tax bill if there are significant vacancies in the building. When I represent tenants in commercial lease negotiations a good operating and expense clause I like to use is:

Tenant shall pay its pro-rata share of increases in operating expenses and real estate taxes that exceed the expense stop.  If the building is less than 95% occupied, expenses shall be grossed up to reflect 95%  building occupancy.

Another clause is:

Base Year 2019, grossed up to reflect 95% occupancy. Request copies of the actual operating Expenses for the previous year and what is budgeted for the current. To control your Increases in operating expenses request a five percent cap on controllable operating expenses

Length of the commercial lease agreement

You may be looking for a long or short term lease. Factors such as the age and stability of your business and plans for growth, the nature of your work and the changes you’ll expect your company to go through will affect your decision. The “term” of your lease means it’s length in time in consecutive months to even years. There are many factors that can dictate what you negotiate in your lease, your financial and credit worthiness as a tenant, market conditions etc. In commercial leasing it is expected that a “normal “ lease term is anywhere between 3-5 years in length. You may be able to get out of a long term lease by turning over your rental to another tenant by subleasing or assigning your lease. If you’re uncomfortable with a lease longer that a year, but the landlord is looking for a tenant to sign up for five years, the deal may not be workable. Is there a reasonable likelihood that the landlord will agree to a shorter term? It will depend on current conditions in the real estate market. Like many other issues in lease negotiations, the landlord’s willingness to bend a bit may depend on whether you’re the only tenant looking or if there are a handful of tenants that are looking at the same space. In a tight market such as today it tends to be a Landlords market where little if any concessions are made on short term leases.

Lease Options

The landlord’s willingness to let you extend the lease or expand into additional space in the future. When you negotiate a lease, chances are you’re not focusing much on what will happen at the end of the lease. It’s worthwhile, however, to give the matter some attention now. If your business does well and the location continues to be suitable, you may want to stay another three, five or even ten years. You have to ask yourself , “If you see yourself outgrowing the current space in three to five years”. You may also consider a “first right to expand” clause giving you the ability to grow without actually moving again. Keep in mind the landlord may legally not able to give you an option to expand for example, other tenants in the building may have options on the space you’ll be renting once your lease expires, you’ll want to know this up front. The idea to have options in your lease is to give you flexibility should you include the ability to renew your lease under the same or similar rental terms. If you like the setup and the location is convenient, and especially if your business depends on the surrounding area you may want to avoid the expense and work of relocating, especially if you put a lot of improvements into the space. When you are just starting out you can’t know for sure how you’ll feel when the lease term ends. An option to renew your lease is the best way to hedge your bets. From the landlord’s point of view, however, option to review clauses are not desirable because the landlord won’t know your intentions until well into the future and often times you’ll have a “notice period” to let the landlord know in advance if you would like to exercise your option.

Renovations

Who pays to fix up your space and makes the improvements you want? If you want to have the space customized to your specifications, you’ll may want to hire a space planner, architect or contractor exactly what needs to be done and what it’s likely to costs. There are many ways the landlords and tenants can split the responsibility and costs of renovations and how to negotiate the best deal. If the expense is significant to you, you’ll want to learn if the landlord is amenable to paying for some or all of this work. If the landlord isn’t willing to pay for renovations you may decide that the other items of the deal are so good that you can afford to arrange and pay for the renovations yourself. When I consult with a tenant one of the first things I ask them is, What is important to you? Size, location, rent abatement, lease rate or tenant improvement allowance? If its an established business maybe rent abatement is not as important as tenant improvement allowance, or if it’s a start up company rent abatement tends to be more important that tenant improvement allowance. The most common way for landlords and tenants to allocate the expense of improving commercial space is for the landlord to give you what is knows as a tenant improvement allowance (TIA) this often is a price per square foot rate up to a maximum amount, any cost above this (TIA) is the responsibility of the tenant to pay for or the landlord amortizes that amount over the lease term. Here is some quick math to determine the Landlord Tenant improvement contribution.

Lets say the cost of the TIA is $63,000. You divide that amount by the square footage of the space you are occupying let’s assume 1671 SF = $37.70 PSF. (The landlord contribution is $10.00 PSF). Your remaining balance is $27.70 PSF. Divide that $27.70 by the lease term lets say 5 years, that equals $5.54 this is the amount per square foot that is added to your initial base rent and amortized over the lease term.

Here are some of questions to consider when reviewing your commercial lease agreement:

• What you pay in rent
• What other expenses you pay
• How your rent changes over time
• When you move in
• How long you can stay in the space
• Your ability to assign the lease or sublet the space
• Your rights and obligations when the lease is running
• Your landlord’s rights and obligations
• Your rights and obligations when the lease expires
• What your landlord is throwing in for free

Investing In Commercial Real Estate?

Looking to invest in Arizona Commercial Real Estate? At ICRE Investment Group, we work with commercial investors, property owners, companies, banks, and commercial loan servicers seeking the highest quality of services in the greater Phoenix, Scottsdale, Mesa and Tempe Arizona regions. Contact us for more information.

 

 

Subletting and Assignment of Lease: What is the Difference?

Subletting and Assignment of Lease

Have you considered subletting your space? There are several ways to get rid of some or all of your space you lease that you don’t need. You can have language is your lease that simply ask to give up some space. You may elect to turn part of the space back to the landlord if your lease has a clause in enabling you to contract your space or you may have the option to terminate the lease. Today I want to talk about your option to sublet and/or assign your lease. I’ll explain the difference between Subletting and Assigning your lease you’ll what to know the difference and what rights under your lease you have to exercise either option. For lease negotiation purposes, there is usually little difference between subletting and assigning. For that reason, we often lump the two methods together and refer to them as “transfers”.

The difference between subletting and assigning

Subletting: If you transfer just part of your leased space to another tenant, on a temporary or permanent basis, its called a sublease, often times the sublease rate negotiated is below market rents with flexible terms in order to entice someone to sublet your space as apposed to going direct. The person who subleases is called a sub tenant. In a subleasing arrangement the sub tenant pays rent to you, the tenant and the tenant pays rent to the landlord under the same terms and conditions of your lease. If there is a sublease clause in your lease most often the Landlord will have to approve the sublessee and run a credit check just like they would with a normal tenant, the approval of which often is timely. You as the Tenant are ultimately responsible for the performance of your lease.

Assignment: By contrast, an assignment occurs when you transfer all your space to someone else (called an assignee) for the entire remaining term of your lease. (You can instead terminate the lease), which is often preferable if you want to move on and never come back, you’ll look for someone to completely take over the lease-assignment. In an assignment, the new tenant pays rent directly to the landlord Importantly, since you’ve given away all of your interest in the lease, you have no rights to retake the property or to evict the assignee for nonpayment of rent. You have to be careful not to assume that because you sublet your space or assigned the entire lease to another tenant, you’re relived of some or all of your obligations. Often, you’re still responsible for paying the rent if they subtenant or assignee fails to pay and making good on other lease obligations unless the Landlord releases you of financial obligations of the lease. Most landlords prefer that the Tenant buy-out their lease and go direct with a new Tenant rather than doing a sublease or assignment arrangement for a couple reasons

1) Extend the lease beyond the initial maturity date

2) Market conditions most likely changed since the initial lease was signed, the market rents most likely have increased since the original tenant took occupancy.

Here is an example of Subletting/Assignment clause, please note, this language is not a substitute for personalized advice from a knowledgeable real estate attorney, always consult an attorney who is licensed to practice in your state.

Tenant shall have the right to assign its lease or sublet the premises with the Landlord’s prior written consent providing that the Tenant or sub lessee will not violate any other restrictive covenant, then in effect in the center and of which Tenant has notice. It is expressly understood that Tenant shall have the unrestricted right to assign, sublet, license or transfer (hereinafter collectively “Transfer”) any or all of its rights and privileges under the lease.

You should consider both options and the consequences before deciding to subletting or assign your lease. You may find yourself wanting to move back into your space and if you assign your lease you give up that right. If you can’t terminate your lease which is the cleanest and lease complicated solution be sure that any assignee is a rock solid Tenant, or structure the transfer as a sublet, so that if the subtenant falls short, you can at least retake and use the space.

Investing In Commercial Real Estate?

Looking to invest in Arizona Commercial Real Estate? At ICRE Investment Group, we work with commercial investors, property owners, companies, banks, and commercial loan servicers seeking the highest quality of services in the greater Phoenix, Scottsdale, Mesa and Tempe Arizona regions. Contact us for more information.

Using the Starker Exchange Technique

the Starker Exchange Technique

What is a Starker exchange and how can commercial real estate investors utilize it? Many of you that are reading are familiar with a 1031 exchange, if not you can read one of my many articles on the topic 10 Things to know about a 1031 Exchange That I previously published. Moving into the advanced state of a 1031 IRS tax code is the Starker Exchange. This is a very special area of a 1031 Exchange in which you can find a buyer for your property, then go out and find what you want to own, and still qualify for the benefits of the 1031 Exchange. Starker exchanges are very different to any other kind of exchange, and are full of pitfalls that can turn a potential savings of would-be tax liability into a nightmare of audits and future penalties. A Starker exchange begins when the first party initiates the exchange by entering into an agreement to sell a property they own. This first party follows a very strict set of rules that allow this partner to actually deed title in the normal way it would be transferred by a sale. However, the proceeds of the sale that is the purchase money, must be kept away from the seller, pending the ultimate purchase of a replacement property. This replacement property will become the exchange property which will hopefully meet the full test of the rules and regulations of the Starker 1031. The advantages of using a Starker exchange technique is that it can put you firmly into the shoes of a buyer. The idea behind the Starker 1031 allow you to sell now, and exchange later.

The Rules and Regulations of the Starker Exchange

The tax benefits only apply to that portion of the property you give up and the property you take that qualified as like kind property. The idea of like kind property is not its quality or category, but the intent of ownership, the intent being owned for investment purposes.

You must follow the time rules exactly as they are prescribed. You must identify a potential property you are going to acquire within 45 days of the date you transfer your deed to a buyer. Second, you must take title to the replacement property within 180 days from the date you transfer your deed of your old property to a buyer. Sounds simple, right? The problem is the first 45 days. You can identify several properties just in case one or more of them don’t work out. By the time you go through the due diligence, and discover things on the deal that don’t hold up, you can back out and proceed to move forward on another property, however that 45 days doesn’t restart. You cannot have access to the money paid to you for your property when you sold it, this is held by a 1031 Exchange accommodation. An accommodation is someone who helps facilitate your 1031 exchange (an Intermediary).

Because of the nature of exchanges, there will be at least. Two property owners who are affected. Keep in mind too that as exchanges are generally transacted through brokers there may also be two or more brokers in the transaction. Exchanges usually affect three or four parties, the owners of at least two properties and the brokers(s), and therefore each will come with different view points and perspectives in how they approach the transaction.

Investing In Commercial Real Estate?

Looking to invest in Arizona Commercial Real Estate? At ICRE Investment Group, we work with commercial investors, property owners, companies, banks, and commercial loan servicers seeking the highest quality of services in the greater Phoenix, Scottsdale, Mesa and Tempe Arizona regions. Contact us for more information.