knowing the basics
It finally happened! After months of searching, you’ve found the perfect spot. Perfect size, floor-to-ceiling windows, hardwood below and the cutest little block. You want it so badly, your heart flutters and your belly spins every time you think of losing it to someone else. You simply must have it”¦now!
Perfect spots, though, often come at a price. It’s not just about space and location, it’s about money, timing and responsibility. The wacky world of commercial real estate has some major differences from its residential cousin. Brushing up on the basic language and courses of dealing can go a long way toward helping you understand and negotiate the best possible lease.
Here is a list of mission-critical terms and concepts:
Rent Per Square Foot/Year
While residential rent is often quoted per month, commercial rent is usually quoted in $/square feet/year. To figure out your monthly rent, multiply the total gross square feet by the dollar value and then divide by 12. For example, if a 1,000-square-foot space is quoted at $12 per square foot, you would multiply $12 times 1,000 to get $12,000 and then divide by 12 to get $1,000 per month.
Useable vs Gross Square Footage
Landlords quote the “gross” square footage (GSF) as the outside dimensions of the building and often include shared space like stairwells, hallways and elevators, rather than just listing the inside space. Be sure to measure the inside space carefully. This is your “useable” square footage (USF). The difference between GSF and USF is your loss factor. Make sure you know your USF. It is often 10-25% less than the GSF. If the loss factor is bigger, you can usually use this as a bargaining chip.
Some spaces will have a C.A.M. or common area fee. Make sure you know the amount up front and see if you can cap or fix it so the landlord cannot unilaterally raise it quickly during the lease term. But don’t be surprised if you lose this battle.
Landlords often seek the right to raise your rent to account for changes in real estate taxes, CPI, energy costs and more. While real estate taxes are pretty standard, try to keep the others out and ask the landlord to fold any increases into a fixed, scheduled increase. This helps ensure fewer surprises down the road.
Plain Vanilla Box
In an older space, very often the biggest start-up expense is demolishing and cleaning out the space. If at all possible, ask the landlord to deliver a “plain vanilla box,” which means a space that is cleaned out with four walls and oftentimes a restroom, unless you like the current configuration.
You may even want to go a step further and ask the landlord to either give you 2 to 6 months of free rent in order to allow you to build out the space or negotiate to have the landlord deliver the space built and not pay rent until such date. If you are willing to commit to a longer lease or the space has been unoccupied for a time, build outs and allowances are fairly common, so don’t be afraid to ask.
Alterations and Fixtures
Draw up a plan or have an architect draw up a plan describing any alterations you plan to make before signing the lease and attach it as an exhibit. Then add in a clause that says that the landlord agrees to the alterations in the exhibit. This lets you hit the ground running and avoids the need to negotiate down the road.
HVAC is the central air conditioning, heating and ventilation system. Find out whether a system is installed, what the capacity is, whether it’s still under warranty and who is responsible for service. Installing an HVAC system is a huge expense and paying for repairs beyond ordinary maintenance can be prohibitive. It is customary for the tenant to cover basic maintenance, but see if you can get the landlord to cover larger repairs.
Goodguy, Guarantees and Exits
The Goodguy Clause is the magic “out” that most first-time lease-signers have never heard of. If at all possible, do not sign a personal guarantee on a commercial lease, rather consider offering to sign a Goodguy Clause. A commercial landlord’s biggest nightmare is not that you stop paying rent, but that you stop paying and never vacate the space. A goodguy clause says that you are not personally liable for the lease as long as you vacate the premises, should you stop paying rent. The entity that signed may be liable, but you are personally off the hook. This brings up the issue of who actually signs the lease. It’s not a bad idea to create an entity other than yourself to do this for a number of reasons that your business lawyer or advisor can explain to you in more detail.
Many new studio owners want some kind of escape clause that lets them break the lease by paying an agreed upon amount of money. All I can say is, a goodguy clause and shell entity should let you sleep at night; besides, if you were the landlord and a prospective tenant was begging for an escape clause, do you think you’d be more or less likely to get the space?
If you sign the lease as an individual or sign a personal guarantee and are nervous about the business, you might want to consider a shorter duration with a series of options. But, if you love the space, you’ve negotiated great terms, you are confident in your ability to succeed, you have a shell entity that will sign the lease and a goodguy clause in lieu of a personal guarantee, why not go for the longest lease possible and ask for an option to renew? Maybe a five- or 10-year lease with an option for a similar period. Your downside is essentially the loss of your security, as long as you vacate should things not work out. And the longer the lease, the more likely you are to get front-end concessions.
Unlike in the residential arena, where one-month’s rent is common, many commercial landlords will ask for up to six months’ rent, especially if you are asking them to allow a newly-formed entity to sign and/or requesting a build-out allowance. Try to negotiate down to one or two months but don’t be surprised if there is not much movement.
If you go through a broker, remember they work for the landlord, not you, and are obligated to act not in your best interest, but in the landlord’s. Also, in the world of commercial real estate, it is customary for the landlord, not the tenant, to pay the broker’s fee. Don’t agree otherwise without a really good reason.
This simplified overview is intended to get you going; but understand it’s not personalized legal or business advice. With a little luck, you’ll be enjoying the consequences of your original lease negotiation for a long time, so take the time and invest in a good real estate attorney and business advisor. It’ll be money and time well spent.
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