The success of your franchised business depends upon many factors. Finding a preferred location is a crucial step for establishing a profitable enterprise. But negotiating a fair commercial lease with the help of an experienced lease attorney can protect your interests and save you money for years to come.
Commercial leases are typically weighted in the landlord’s favor. Many require a personal guaranty, meaning that your home and other assets may be at risk and some landlords attempt to restrict many of your rights. But a knowledgeable lawyer can help even the playing field.
Negotiation strategies for commercial retail leases
Leasing space is a considerable expense for businesses, big and small. But hidden costs and restrictions can exponentially increase a tenant’s liabilities and reduce revenue opportunities. Here are ten common issues that should be carefully negotiated with landlords:
1. Personal Guaranty
Landlords must make payments of their own to lenders, and some may have been burned in the past by tenants, so most expect strong personal guarantees. This means that a landlord could go after your home, investments and/or other personal property for past-due rent and additional rent (charges for taxes, insurance and operating expenses, for example). Your attorney will try to limit the personal guaranty period as much as possible, which could be months or years.
Having leverage is vital to limiting the length of a personal guaranty. The best time to address this is before lease negotiations begin when coming to terms on a letter of intent (LOI) with the landlord. Unfortunately, many tenants sign an LOI before retaining counsel. While LOIs are typically non-binding agreements (meaning that the LOI is not a binding contract), landlords expect that the business terms negotiated in the LOI will not be re-negotiated when negotiating lease terms. If not negotiated at the time of the LOI, or if the terms are not acceptable, it is important to have strong counsel advocating on your behalf to limit the guaranty.
2. Release Upon Assignment
Landlords may seek to hold you accountable for the lease terms even if you sell 100% of the assets of your business. This practice became more common after the Great Recession of 2008-2010 and is another feature that should be negotiated before signing the lease. Landlords want to keep all parties on the hook for as long as they can. Can you imagine selling your business to another party and still personally guaranteeing the lease negotiations that your Buyer now has?
While some landlords may reconsider an assignment provision in a softer real estate market, most are reluctant to renegotiate after the lease is signed. However, before inking the lease agreement, tenants can push for release if the franchisee to whom they sell the business has an equal or higher net worth.
In the case of shopping centers, landlords often want the right to move tenant businesses. One example is relocating a smaller tenant to a new location to consolidate multiple spaces to attract a larger tenant. Moving your business can be highly detrimental to your business. However, if the landlord refuses to drop those rights, your attorney can negotiate several provisions, such as:
- Limiting relocation to certain times of the year and days of the week
- Specifying areas where the landlord can or cannot relocate your business
- Requiring the landlord to pay all costs of the relocation and reimburse you for lost revenue due to the interruption in doing business
- Abating base rent and additional rent during the time you are closed for business
Also, the agreement should specify that if you wind up in a larger space, your rent and additional costs will not increase. However, if you are placed in a smaller location, your rent will be reduced based on the difference in square footage.
4. Operating Expenses
Tenant leases with landlords who own shopping centers are triple net leases, meaning the tenant pays a base rent amount plus a share of the owner’s expenses for insurance, taxes and operating expenses. These are also known as common area maintenance charges or CAM charges. Several items should be excluded from CAM charges, including:
- Landlord capital expenditures
- Building or shopping center depreciation
- Landlord legal fees for collecting back rent
- Repairs or damage covered under an insurance policy
- Repairs or damage caused by the landlord or their agents
- Interest and penalties incurred by the landlord for failing to meet their financial obligations
- Taxes related to rental income
- Property management fees over 5%
- Costs related to testing or cleanup of hazardous materials not caused by the tenant
It is also advisable to limit CAM charges to a certain percentage increase for each year of the lease.
5. Maintenance Obligations
A common concern in leasing commercial space is the shape and maintenance of the heating, ventilation and air conditioning (HVAC) system and which party is responsible. The HVAC system should be in good working order when the franchisee takes possession.
The tenant should negotiate a provision that the landlord will pay all standard repair or replacement costs over the first 12 months of the lease if the system is old. If the tenant becomes aware that the HVAC system is on its last legs after signing the LOI, they should look to negotiate a larger tenant improvement allowance or the installation of a new HVAC system before taking possession of the property.
Tenants should have architects, contractors, local officials and other appropriate parties inspect the space before signing the lease. Every franchisee needs improvements made, which may require permits. These can be complex issues when dealing with municipalities.
Negotiating a permit contingency allows tenants to withdraw from the deal when the time or cost of getting a permit is prohibitive. Landlords are often reluctant to agree to these contingencies, so conducting due diligence on the space before the lease is signed is extremely important.
Like warding off issues over permits, it is advisable to negotiate a signage contingency. This protection applies if you cannot obtain approval from all governing bodies. Most commercial landlords and local municipalities must approve any sign that is displayed.
Due diligence can lead to pre-approval of the franchisor’s signage requirements before finalizing the lease. Also, since signs are important to every business, don’t forget to negotiate your sign’s right to be on the shopping center’s pylon or monument, as well as negotiating its location and size on the pylon or monument.
8. Right to Review the Landlord’s Books and Records
Since the landlord will pass along many of their costs to you through additional rent, it is critical to have the right to review the records related to those charges if you believe you are being overcharged. If the review shows you were overcharged by a certain percent, then you should be able to have the records audited and the landlord should reimburse you for the costs of the audit.
Landlords should make annual reconciliation statements available within a reasonable amount of time at the end of their fiscal year. The documents should itemize their taxes, insurance premiums and allowable operating expenses. Tenants should also have unrestricted access to all applicable invoices, tax bills and supporting documentation.
9. Landlord Repairs
The lease should stipulate the amount of time a landlord has to make needed repairs. If the owner fails to meet the agreed-upon repair period after receiving written notice from the tenant, the tenant can take additional steps to initiate timely repairs.
An emergency self-help clause may allow the tenant to make the repairs themselves if the landlord hasn’t responded within 24 hours. Under this clause the tenant will be reimbursed for the costs within 15 days of submitting the invoice. Agreements allowing the tenant to abate rent payments until repairs are made usually light a fire under landlords to deal with these issues promptly.
10. Exclusive Use
Tenants, especially those who operate successful franchises, often depend upon being the only enterprise of their kind in a shopping center. Negotiating an exclusive use provision can be vital to that success. The agreement should clearly outline the tenant’s rights.
To have teeth, the exclusive use clause should include significant penalties for violating the clause, such as giving tenant the right to abate rent and additional rent payments by 50% to 75%,. Landlords often look to limit these penalties to 12 months or other timeframes. at the end of which, the tenant must decide whether to pay full rent or terminate the lease.
Commercial lease agreements must be carefully negotiated
Starting your own business is an exciting time and may be the culmination of a life-long dream. However, it’s crucial to painstakingly review every aspect of your franchise agreement as well as the lease agreement for the “perfect” space you’ve found for its location. Just negotiating the business terms with the broker’s assistance, is not enough to protect you as a tenant in a commercial lease.
Regardless of the nature of your franchise, these ten common issues for negotiating a favorable commercial lease are just a drop in the bucket of all the items that you need to carefully consider. Working with an attorney who understands franchise law and has considerable experience drafting commercial lease agreements with landlords can help you start your business venture in the best possible position.