You're facing a major lease agreement. The lease document is lengthy and written in mysterious "legalese." How do you know what the terms really mean and what the implications are for your business? A misunderstanding or overlooked issue today can become an expensive problem in the future. So it's useful to be able to interpret the terms of today's industrial lease documents.
The conventional wisdom is that leases are written to benefit landlords more than tenants. It's no surprise that landlords need to protect their interests just as much as tenants do, and no secret that brokers are typically paid by the landlords. However, with an understanding of your lease document - and representation by an ethical, skilled broker working on your behalf - you can secure a lease agreement that is a win-win for both parties in the transaction.
Types of Leases
One confusing aspect of leasing is that even industry insiders can be inconsistent in their descriptions of the various kinds of leases. Most industrial facility leases are a variation of "gross" or "net." Net leases are commonly used for single-tenant industrial properties, while modified gross leases are typical in multi-tenant facilities. These terms refer to how roles and responsibilities are divided between the landlord and the tenant, how various property expenses are paid, and who pays them.
With a full-service gross lease, the tenant pays a lump-sum monthly rent to the landlord, and the landlord in turn pays for taxes, maintenance, insurance, and utilities. The tenant also must pay for any additional property insurance, taxes or utility expenses incurred by their occupancy, and for their share of any future "pass-through" increases in property operating expenses.
A modified gross lease is common in industrial facilities. It is similar to a full-service gross lease, but certain operating expenses - e.g., real estate taxes, electricity, maintenance, or janitorial services - are paid directly by the tenant. This lease structure is useful if each tenant has a different business and has different needs, and/or if some utilities are directly controlled by individual tenants.
Like gross leases, net leases come in several varieties. A net lease requires the tenant to pay some or all of the property expenses directly to the source - whether a service provider, tax authority, or insurance company, for example. Since there are no set standards as to what costs may be excluded or included in a net lease, the lease is usually customized according to need.
With a single-net lease, the tenant pays a monthly lump-sum base rent as well as the property taxes. The landlord is responsible for all other operating expenses of the property and the tenant's premises.
With a double-net lease, the tenant pays a monthly lump-sum base rent as well as the property taxes and the property insurance. The landlord is responsible for all other operating expenses.
A triple-net lease, often used with single-user industrial facilities, means that the tenant pays "TMI" - taxes, maintenance, and property insurance. Tenants also are responsible for all costs associated with their occupancy, including personal property taxes, janitorial services, and all utility costs. The landlord is responsible for the roof and the structure, and sometimes the parking lot. If you are considering a triple-net lease, it's important to clarify the parking aspect up front or risk disputes down the road. A triple-net lease gives the tenant near-total control over the property, as long as they comply with the use limitations and other clauses specified within the lease. The disadvantage is that triple-net leases often cannot be cancelled except under extreme situations, such as an eminent domain ruling.
An absolute triple-net lease or bond lease is triple-net lease with one key difference: under no circumstances can a tenant cancel the lease. Property investors and lenders like bond leases, for obvious reasons, but the arrangement works only if the tenant company is reasonably expected to have a long lifespan.
Length, Holdovers, and Options
Landlords like long-term leases and will offer a lower rent rate and more concessions for a lease of 10 years or more. Companies, however, prefer flexibility, especially given the fast-changing pace of today's global economy. Many tenants aim for the best of both worlds by assuming a long-term lease with a cancellation option if at all possible. Some landlords will require a certain amount of notice or other compensation to minimize potential loss of income from vacancy.
On the other hand, industrial leases today often have shorter life spans than in the past. You will likely pay a relatively high rent for a lease of five years or less, but for some companies under certain conditions, the higher cost makes good business sense.
You also can request an option or options to extend the lease at a rental rate structure that you should negotiate up front. Typical arrangements include continuing per lease terms, continuing at a rate adjusted by a certain percentage, or continuing under prevailing market conditions.
Another lease length issue to consider is a possible holdover - staying in your space an extra one or two months beyond the lease expiration date. Landlords typically require holdover rent that is 200 percent of the last month's rent, but you may be able to negotiate a somewhat lower rate.
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
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.
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 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