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A Commercial Tenant's Guide to Lease Terms

Most Area Development readers are well-versed in the terms of industrial leases, but potential inconsistencies and new issues make a review well worth your time.

Dec/Jan 08
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Other Terms
Premises: The term "premises" seems simple enough, but it should be clearly defined in your lease document. If you are leasing an entire building, for instance, does the lease include the parking facility? Are you responsible for parking maintenance? If you are leasing part of a multi-tenant facility, look closely at the landlord's definitions of common areas and your leased space. Since rent is charged per square foot, your landlord will, naturally, seek to maximize the measurement of the space you are leasing. Measurement, of course, is subject to interpretation - one can measure from the outside walls or the interior walls, for example, or include obstructed unusable space in the square footage.

Operating Expenses: Your lease document should include a complete description of the expenses for which you will be charged. Operating expenses are recurring expenses that are essential to the continuous operation and maintenance of a property, and the term does not include real estate taxes, insurance, mortgage payments, capital expenditures, and depreciation. Operating expenses can include repairs, trash removal, salaries of the landlord's employees, building improvements or operations of common areas (see below), among other items. Some of these expenses represent a potentially significant future increase in cost of occupancy, so it is best to read the list closely. Also, unscrupulous landlords will add expenses that you should not have to pay, such as the cost of marketing the property to other tenants or for square footage of the landlord's office space within the property.

Common Area Maintenance (CAM): In a multi-tenant facility, the landlord typically assumes responsibility for the structural elements of the property, while the CAM charges are divided among the tenants of the building and are included in your rent payment or paid separately, depending on your lease. Your CAM charges will be based on the square footage you lease as a percentage of the overall facility, and typically are summarized in the lease document as a percentage of the common areas. Again, it's important to know exactly what square footage will be used as the basis of the CAM charges and, again, examine the list of operating expenses closely to determine exactly what you are paying for.

Escalation: The escalation clause allows the landlord to increase the rent at a future time to stay abreast of inflation. The escalation may be defined as a fixed increase over a defined time period or as a cost-of-living increase linked to a government index - e.g., Consumer Price Index - or an increase directly tied to increases in operating the property.

Base Year: Base year refers to the first 12 months of a tenant's occupancy or the calendar year, depending on the timing of the lease. Base cost is the operating expenses of this first year and is used as the basis of future increases in operating expenses that are passed through to tenants. Therefore, you should note how the landlord defines the base year, because the beginning of the second year is when you begin paying pass-through expenses, if applicable in your lease.

Tenant Improvement Allowance: Landlords often will grant a tenant improvement allowance so that a space can be customized for your needs. The allowance is typically offered in terms of dollars per square foot, with the tenant responsible for any charges above the landlord allowance. Landlords and tenants alike usually prefer to control the construction process, and larger tenants have more leverage in obtaining a "tenant work letter" that gives them control over the project.

Subordination and Nondisturbance:
Unless your landlord is a public company, it can be difficult or even impossible to know whether the company is financially stable and reliably paying the mortgage. To assure your business continuity, you can add clauses to your lease that will preserve the lease with its current terms should your landlord default on the mortgage and the lender assume ownership. Without this assurance in writing, the lender is not legally required to recognize your lease and you could face eviction or a steep rent increase. The subordination clause will state that the mortgage is subordinate to your lease, and the nondisturbance clause will state that the lender and future owners of the property cannot terminate your lease as long as you continue to fulfill your obligations. This clause is especially useful if area rents have risen considerably while you have operated under your current lease, as one of the first things the lender or a new owner would want to do is increase rent to market rates.

Americans with Disabilities Act (ADA) Compliance: Although the ADA has been on the books for many years, many buildings are not ADA-compliant. If your landlord is going to build out your space, make sure your lease includes a clause requiring the buildout to be ADA-compliant. Once you take occupancy, your business could be at risk for compliance, and the legal fees and the cost of retrofitting can add up quickly.

While this list obviously doesn't cover every possible lease term that you might see, these are some of the terms that can cause the most trouble if overlooked. What's important is that your lease terms point to the potential hazards for your business. The good news is that mysterious leasing terms are easy to understand at all once you're approaching them from a place of knowledge.

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