By Anna Woodworth, Senior Auditor
Most real estate gurus can tell you about the important aspects of a commercial real estate lease: rent, term, options to renew, etc. But while location, location, location may be the biggest factor in signing on the dotted line, some lesser known parts of the lease can bring big headaches to tenants that haven’t thought through the impacts a “hidden clause” can bring.
When a tenant doesn’t have an attorney on their side who specializes in commercial lease negotiation, the business is at a disadvantage both during the negotiation and later as the consequences of their inexperience come to fruition.
Below are some tips for commercial tenants to think about as they negotiate their lease.
1. Operating Expenses
Not only does the tenant pay rent, but in many commercial leases they also pay their pro-rata share of operating expenses. Operating expenses can include utility costs, repairs and maintenance, management fees, and staff salaries to name a few. These expenses can and should be negotiated. Contract clauses can include a cap on management fees, and the exclusion of costs for structural repairs to the property, salaries above the level of building manager, legal and accounting fees, corporate overhead, etc. Each of these cost centers can add more money to the landlord’s bottom line and can cost tenants dearly.
Gross-ups are a mechanism that allow landlords to recoup building costs when the property is less than 100% occupied. Like everything else in a contract, gross-ups can be negotiated. There are many costs which are not 100% variable, yet because these contract clauses are often vague, many landlords gross-up 100% of the cost to the 100% occupancy threshold. For example, the cost of landscaping does not vary with occupancy, however the cost of electricity does. When a lease allows for gross-ups, tenants should make sure to include language stating that only variable expenses should be grossed-up, and negotiate specific variable percentages depending on the cost category.
Additionally, the tenant does not have to allow a landlord to gross-up to 100% occupancy. Many tenants negotiate for a 95% occupancy gross-up, which will save money in those years when the building is not fully occupied.
3. Above Standard Services
Tenants should be very aware of what costs they will be responsible for above rent, taxes and operating expenses. Many landlords provide electricity and heating/cooling during business hours, but if a tenant wants the lights on past 6pm, that’s going to cost extra. Landlords routinely put in a cushion above the actual costs for providing such services, which gives the landlord a nice extra stream of income. Tenants can decrease their exposure regarding above standard services by inserting lease language that limits landlord’s recovery to landlord’s actual costs.
4. Audit Clause
Commercial leases should have specific, well thought out audit clauses. Landlords want to limit the amount of time a tenant has to review the year end reconciliation statement, and bind the tenant to that statement if no questions are raised during that time period. Audit clauses do not have to be long to be effective for the tenant. They should give clear guidance on the procedure to follow, what can be reviewed, if documents can be reviewed remotely (thereby eliminating travel costs), how long the landlord must keep their records, as well as what to do when an audit reveals mistakes in the reconciliation statement.
The above are a few general ideas for negotiating a commercial lease. Chelepis is here to help. We are happy to review potential leases and negotiate the best situation for tenants as they search for their new home. Businesses have enough to worry about, getting hit with hidden fees from their landlord shouldn’t be another concern. With a little preparation and good negotiation tactics, commercial leases can be fair for all parties.
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