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Letter of Intent (Offer) to Lease Commercial Property PDF Print E-mail
Written by Darren M. Lizzack, MSRE   
January 10, 2010
Darren Lizzack, MSRE
Associate VP
NAI James E. Hanson
201 488 5800 x104
dlizzack@naihanson.com
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Letter of Intent (Offer) to Lease Commercial Real Property

I hope you all enjoyed the holidays and I want to wish you and your families a prosperous 2010! Last month, I provided my readers with information on the Letter of Intent (Offer) to Purchase/Sell Real Property. With today’s stringent borrower requirements and increased scrutiny in the banking industry, more companies are steering away from purchasing commercial property and leaning towards leasing options as a good alternative. That being said, this month’s news article focuses on the letter of intent (offer) to lease real property. What are the most critical elements to consider when attempting to lease commercial space in today’s environment?

Size

There are very few items that get negotiated when an offer is presented to lease commercial real estate and I always tell people that almost everything is a negotiation with the exception of size. Unfortunately, size can also be subjective because of common areas. It is easy to measure interior space that a company intends on leasing, but the more challenging issue is measuring space that a tenant pays for (rentable space) that they do not actually use themselves. In other words, landlords supposedly measure the building and all areas that become common to each tenant is supposedly divided up equally amongst all the tenants in the building. Therefore, the size oftentimes is open to interpretation and must be carefully considered during the lease negotiation process.

Rent

This seams the most straight forward item to consider if you are a tenant negotiating the business terms that will eventually finds itself imbedded in the lease documents. But leases vary in length and while a company may be concerned with the rental rate in the first year of the lease, what about years 2 through the “X” year? How about what a tenant pays in rent during the option period (if applicable)? This items needs careful consideration because it can cost a tenant or a landlord a lot of money over the life of a tenant’s tenure.

Additional Rent

A prospective tenant should understand the ramifications of additional rent which typically appears in a lease document and may be overlooked. This section determines what other obligations the tenant has under the lease to the landlord and should be examined very carefully. This coincides with rent and the size because they go hand-in-hand when a landlord conveys what other monetary responsibilities they will have during the term of the lease as well as any extensions, renewals etc. Therefore, when negotiating the business terms of the lease, this section should be included in the letter of intent (offer) to lease space in a commercial building.

Term

This item describes how long a lease is going to be committed to by the parties and can have a dramatic effect on a tenant and landlord. Tenants often lease space because it provides them with flexibility as the company matures over time and they may want to limit their exposure while a landlord generally wants to have long-term commitments because they face loss of income if their space sits empty. It also costs money to operate a building even if there are no occupants. The landlord does not simply stop paying their mortgage, real estate taxes, insurance, utilities, etc. when a tenant vacates. Therefore, this is a very important term both sides must realize when negotiating the business terms of a transaction.

Rent Commencement Date

This date often gets confused with the lease commencement date and should be clarified up front during the negotiating phase. I am always asked what the asking rental rate is for commercial space I represent. I always explain to people how that is a loaded question because if you simply look at what a comparable space has recently leased for, most people do not know and/or understand what the underlying terms of that particular transaction were which helped determine the rental rate (i.e. free rent, who paid for the improvements required by the company in order for this space to adequately meet their needs for a company’s business to operate, etc.). Hopefully, you can better understand the importance of this date and how it coincides with other variables that must be negotiated up front for a lease transaction.

Security Deposit

This item is oftentimes overlooked in the beginning of the negotiating process. All parties to a lease negotiation are concerned with aligning the interest of all parties involved and this item is very sensitive because of what it involves. A security deposit represents moneys that a landlord will take from a tenant typically when a lease gets executed. Tenants want to tie up as little money as possible in order to free up their capital for other business functions. Landlords, by the same token, want protection in the event something goes wrong with their tenant (i.e. tenant fails to pay rent, additional rent, they disappear in the middle of the night, they go bankrupt, etc.). The items mentioned only touches the surface of this topic and should be carefully thought through during the negotiating process.

Use

Landlord’s always want to know what the tenant intends on using the demised space for many reasons depending upon the type of transaction (office, industrial, retail, or land). What is the sense of negotiating a lease for a particular use that is not permitted under the laws and regulations for the zoning of a particular property? When retail is involved, what happens if a similar use is already provided for by another occupant? Landlord’s that own retail centers want to find the appropriate balance by providing a tenant mix that maximizes the benefit to the center and insures their tenants are successful.

Parking

It is always good to know how much parking is provided for whether you are a tenant or a landlord. All properties should provide adequate parking for the intended use of all occupants encumbering space in a particular building. While many building owners do not provide for dedicated or assigned parking, a tenant should know what portion of the total parking is allotted to their particular space. What good is for either the tenant or the landlord to enter into a long-term business relationship when a lack of parking may contribute to the demise of the business operation? How does a tenant ensure that the parking available today is going to be adequate down the road when there are other vacancies not being accounted for? In other words, a vacant building today may provide adequate parking for a tenant only until the other vacancies get leased out.

Assignment and Subletting

This is very important to a tenant because as time goes on, businesses may change hands and they may need to find solutions in order to unwind long-term lease obligations. When businesses get sold, many things happen and it’s good for a tenant and a landlord to understand their rights under their lease agreement; this could be very costly to a tenant. If you own a business, you want to ensure that you have control over your business and you do not want the landlord to taint your ability to sell your business. And from a landlord’s perspective, you don’t want to be in a situation where a tenant leaves you with a less desirable tenant who may not be as financially viable as the tenant they entered into the original agreement with.

Operating Expenses

Operating Expenses are handled differently across product type (office, industrial, retail, land) and each one should be given careful consideration as you negotiate this for any transaction. There are so many different ways to handle operating expenses and if a tenant does not look at this closely, it can be very costly down the road. In retrospect, this can also hurt a landlord if, for example, there are caps on the expense reimbursements required by tenants as a lease goes forward. If you are landlord or a tenant, tell me, where do you “stand” when it comes to this protection?

Summary

If you are a landlord or a tenant negotiating the business terms that are to be incorporated into a formal lease document, you better know where you stand before executing these documents. It makes a lot of sense to spend extra money with your attorney to carefully examine each business term that finds itself into the lease document, and often collects dust in a drawer somewhere until that day when the landlord or tenant tries to push the responsibility off to the other party. It all comes down to, “What does it say in the lease? Who is the responsible party for this issue?” You tell me; are you going to be the one with an ambiguous lease document or are you going to be properly prepared for that problematic day to arise?

Please let me disclose to you at this time that all items that have appeared above are very important, critical issues, and are exclusively my opinion, however, there are many other business terms that should be thought through cautiously as you negotiate the letter of intent (offer) to lease commercial real estate.

I hope you enjoyed this month’s issue and you found some/all of the information interesting and/or useful. If you need additional information on these terms or the ones I have left out, feel free to contact me directly at your convenience at dlizzack@naihanson.com. In addition, please feel free to read up on all my articles; you can find this article and all others archived here: http://njcrea.com/brokerage/nai for your convenience. You may also provide me with feedback and please let me know if there is a topic you would like me to shed some light on in future news articles. And if I am not the one to best answer your specific commercial real estate related question(s), feel free to contact any of my peers that are associated with New Jersey Commercial Real Estate Alliance (www.njcrea.com); I am confident that one of us can help you.

Last Updated on January 10, 2010
 

Comments  

 
-1 #2 Eric 2010-08-31 13:05
Charging higher-than-market rent on a lease option is a good business decision and is legally and ethically justified (subject to some local variations) if the excess money is credited as option money. Some sellers opt to charge just the fair rental value so that only the initial option money is credited toward the purchase. Still another variation is to charge fair rental value and credit a portion of this toward the option. This is a great deal for the buyer, but can lead to complications with financing later, so you should check with your real estate agent or loan officer for details.
http://rentstops.com
 
 
+2 #1 mark sleeper 2010-01-12 15:01
excellent summary - should be required reading for anyone not familiar with the tenants interest in lease negotiation.

happy new year!