Key Questions Small Business Owners Should Ask Before Entering into a Commercial Lease

Date: March 22, 2017

Whether opening your first location or looking to upgrade to a larger space, signing a commercial lease is often an important step in growing your business. But of course, commercial leases can be complex. They may include complicated formulas and strict provisions outlining rights and responsibilities. This means you really need to understand what you are signing.

For starters, it is important to understand that commercial tenants don’t usually receive the benefit of consumer protection and landlord/tenant laws like residential tenants. Accordingly, you must take contract negotiations seriously. And for these reasons, NFIB recommends that you consult an attorney before signing a commercial lease—especially if it is going to be a long-term arrangement.

Is the location a good fit?

As the old saying goes: in real estate, location is everything. While not technically part of a commercial lease, location is a factor that is important to consider before you sign on the dotted line. Location can make it much easier, or much harder, for your business to grow and succeed. For landlords, it’s important to adjust your rental agreements in consideration of the surrounding area. For example, if the property has easy access to major streets and high quality businesses nearby, your property is probably more valuable on the rental market. To the extent possible, you may be wise to ascertain what similarly situated properties rent for in your community.

For businesses looking to lease a property, you want to be aware of what businesses will be around you because this can affect what sort of customers come into your establishment. If you’re in retail, being surrounded by grocery stores and restaurants would likely mean fewer customers in your store than if your business were surrounded by other retail stores. If your business is engaged in light industrial activities, the right location can provide space for your business to operate and grow – without having to deal with complaints from neighboring businesses about things like noise or dust. For that matter, it is a good idea to confirm—before agreeing to anything—that the property is properly zoned for the uses you have in mind.

How rent will be calculated?

Renting a space for your business is often a little different than renting an apartment or house for your residential use. Commercial leases are usually not all-inclusive, and often feature variable costs that combine with “base rent” to form a “total rent” figure that may potentially change from month to month. These variable costs often include things such as pro-rata shares of the building’s property taxes, insurance, utilities, and fees for the upkeep of common areas on the property such as parking lots or lobbies.

Before signing a commercial lease, be sure to ask your prospective landlord if added fees are contemplated. If so, then you should ask for projections of how much these variables typically add to the base rent. If renting space in a strip mall or shopping complex, ask other businesses what they typically pay for these added costs. Some landlords are also willing to cap these costs within certain ranges based on historical costs. Having a handle on these variable costs before you sign a commercial lease is important so that you can determine whether you can truly afford the lease.

Yet of course you may also negotiate a flat-rate lease, where all costs are incorporated into one stable monthly figure. Another possibility is to negotiate a lease that charges a base rate plus a percentage of gross receipts of the business. You should think about what sort of arrangement works best for your business, and consider floating alternative options if you have concerns about the proposed terms of a lease.

What are the key dates?

The Lease Term. It’s important to know and understand the important dates that will affect your mutual obligations under the lease. First, you need to know and be comfortable with the “lease term.” While commercial lease agreements should become effective and binding once all the parties sign, in most cases the lease term will be specified as beginning on an agreed upon date in the future, which you might refer to more colloquially as the move-in date. This is usually essential for the prospective tenant who will need to time to plan and orchestrate a move, and is often useful for the landlord who may need to clean the premises, or address maintenance issues in advance.

Typically, a commercial lease will run for a term of years. For example, a five-year lease might begin April 1, 2017, running through March 31, 2022. And, in most lease agreements, the obligation to begin paying rent begins on the commencement date—i.e., April 1st in our hypothetical. While its possible the lease may specify different payment arrangements, commercial leases usually require that the tenant must pay on a monthly basis—possibly with a few days grace period—consistent with terms that residential renters might encounter.

Renewal Options. And in residential lease agreements, the lease will usually (but not always) specify a date for which the tenant may elect to extend the lease for another predefined term, except that commercial tenants are usually required to make an election on an extension much further in advance than would be required for a residential tenant. For example, it is not uncommon for a commercial lease to require the tenant to give notice of intent to renew six months or a year in advance of the end of the lease term. Of course, in the absence of previously negotiated extension terms, the parties will have to negotiate a brand-new contract if they wish to extend the lease. That said, an existing commercial lease will almost invariably require the tenant to give some indication as to whether he or she intends to seek renewal or not by some specified date.

In some cases renewal is not an option—perhaps because the owner has other plans for the property going forward. To be sure, in the absence of a previously negotiated extension agreement, the tenant has no expectation to remain on the property beyond the term of the lease. And even if the existing lease provides some guarantee that the landlord must allow the tenant an opportunity to seek renewal, the parties are free to renegotiate key terms—such as rent, or maintenance responsibilities—if those terms are not already addressed in a previously negotiated extension clause. But assuming that an extension is possible in your case, it’s important not only to compare rents at other prospective locations, but to consider the costs of moving your business, as well as the potential impact that it may have on your stream of revenue.

What happens if we fail to renegotiate a contract during the existing term?

More often than you might think, business owners tell us that the pre-negotiated commercial lease has expired, but that they have continued operations as normal and have continued paying rent on the same terms as they had during the lease. In this case the commercial tenant is generally allowed to remain on the premises, so long as they continue paying rent. And while they lack the security of a long-term lease, the upside is that they have the flexibility to leave at any point if they might like.

In the absence of previously negotiated terms dictating automatic renewal at a different rental rate, or for a specific timeframe, most states recognize that an expired lease will automatically renew one month at a time—with rent due in the same amount as was due during the negotiated lease. For example, it is possible that ABC Corp. might have previously agreed to terms that would automatically extend the lease (perhaps even raising rent) if the tenant should choose to remain on the premises after expiration of the original lease. But in the absence of such previously agreed upon terms, ABC Corp. can continue operations as normal on a month-to-month basis, paying the same rent as before. But at the same token, the landlord, XYZ LLC, might give notice at any time requiring ABC Corp. to vacate (or to agree to a new lease) within some set timeframe—usually 30 days.

What happens when things go wrong?

Maintenance Issues and Closure. For both landlords and tenants, it’s imperative that you are aware of your rights and responsibilities under a commercial lease. In commercial leases, landlords are often (but not always) responsible for the maintenance and upkeep of the building, grounds, and common areas; while tenants are often responsible for the maintenance and upkeep of their rented spaces. But you may need to look carefully to the terms of your lease agreement to determine who is responsible for plumbing issues, or interior environmental concerns—such as the existence of black mold. Likewise, you should also look to see if your lease specifies who is responsible for any maintenance or repairs that may be necessary as a result of natural events—such as flooding. You may also want to think about whether the tenant will have to pay rent while the building is closed for repairs, and other related concerns that a tenant may have if forced to temporarily close-shop. 

Breaking the Lease. It’s also important to know whether your rights and responsibilities change during an economic downturn. Sometimes commercial leases contain provisions that allow stores to temporarily close, if certain conditions are met, without violating their lease. Other commercial leases require tenants to be open for business for a minimum number of days per year regardless of whether they’re making a profit or not. Relatedly, you should know whether the lease allows an escape hatch for the tenant if it should falls on hard times, and what penalties the tenant may incur if it should seek to get out of the lease early.

Evictions. Finally, we often receive questions relating to the eviction process. Obviously, failure to pay rent is ground for an eviction—as a material breach of the lease agreement; however, you will always want to look to the terms of your lease to see what, if anything, is said as to the process for evictions, and whether the tenant may object to an eviction if they can catch-up on past due rents. As with any contractual matter, your legal rights are governed by the contract. If the contract fails to speak in specifics, then you are likely operating under default contractual principles at state law.

Who is responsible for permits and other regulatory compliance issues?

Your commercial lease should make clear who bears responsibility for regulatory issues affecting the property. For example, it is common for a landlord to assume responsibilities for ensuring compliance with design standards and zoning laws—unless the tenant is initiating changes, as authorized by the lease agreement. Likewise, it is common for the owner to assume responsibility for compliance with access regulations under the Americans with Disabilities Act, and the owner may, in some cases, be contractually obligated to indemnify the tenant for legal expenses in the event of a lawsuit. Conversely, a landlord may insist upon an indemnification provision to the extent there are concerns about the tenant’s conduct on the property.

It is only prudent to think about these compliance and indemnification issues, and other regulatory matters that may arise at the outset to avoid problems down the road. This is yet another reason to get a real estate attorney involved earlier than not. For more guidance, check out the Legal Center’s guide to ADA compliance.

Readers may also find helpful guidance that we put together recently on contractual negotiations, and on handling contractual disputes.

*This article does not provide legal advice. Businesses are advised to retain counsel from a trusted attorney with experience in real estate law.

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