The Landlord's Checklist for a Commercial Lease
- The most basic thing to review in a lease is its initial lease rate. If you can achieve a higher lease rate, as long as it's within the range accepted in your market, you not only make more money but also increase the value of your building. In addition to the initial rate, pay attention to the increases that you're able to get from your tenant. Increases in rent are important to keep up with inflation, as well as with increases in expenses if you're paying them. However, overly large increases, although they can increase your cash flow, typically don't increase your building's value significantly. This is because buyers and their lenders typically focus on cash flow in the first year. With this in mind, you may want to trade overly generous increases for smaller increases on a higher starting rent rate.
- Although tenants often want shorter terms, you should generally negotiate as long a term as possible for your lease. Longer term leases save you money, as you avoid the expense of paying an attorney or agent to help you with lease negotiations. They also increase the value of your building, as buyers typically pay more for a more stable income stream. Although giving your tenants the option to extend their lease life is a nice thing to do and can eliminate the expense of lease renewals if they stay, this option doesn't give you the security of a long lease with a fixed term.
- The rule for expense reimbursements is simple: The more that the tenant pays, the better off you are. A triple net lease, which means that tenants pay every expense of the building either directly or as reimbursements to the landlord, is the most desirable lease structure. It helps to insulate the landlord from any increases in expenses, while also giving the tenants a great deal of control over how they maintain and manage their spaces.
- There are two types of restrictive covenants that tenants may request, both of which are extremely common in retail centers. The first is a "co-tenancy" or "go dark" clause, which says that a tenant can vacate the building if a certain other tenant, usually a large "anchor" such as a supermarket or department store, vacates the property. These clauses can lead to a domino effect, where one tenant's leaving can empty an entire center. Another restrictive clause is a lease term, which prevents the landlord from leasing space to a competing business. Although it may be reasonable, for instance, not to have a Subway and a Quiznos next to each other, allowing Toys R Us to prevent you from renting space to Barnes and Noble because it sells some toys could make it very hard to fill vacancies in your center. The more that you can avoid having these clauses in your leases, the easier your building is to own, manage and lease.
- One clause to request is that a tenant make reports on its sales and financial performance, which you can then share with future buyers. Although sales reporting is common in leases with percentage rent, where a tenant's rent payment depends on how much it can sell, it's rare in other leases. Buyers and lenders are increasingly demanding information on the financial performance of a building's tenants so that they can determine how safe the building's income stream will be. Requiring tenants to share this information with you not only helps you sell the building but also helps you to understand what your tenants may do in the future.