Part 11 – last Article blog

11. Lender issues: Landlords will frequently reject tenant’s suggested lease modifications because they would impair the “financeability” of the property, so the tenant must understand lender concerns. In general, the lender’s primary concern is the assurance of uninterrupted cash flow; anything that might jeopardize cash flow will be carefully scrutinized. Sensitive lease provisions generally include tenant remedies such as rent abatement, offset rights (deducting damages against rent) and lease termination rights.

 Successful negotiation means more than just the rent  As noted above, each step of the commercial lease process and each provision of the lease agreement provides ample opportunity to improve the deal, and conversely, expose the landlord or tenant to costly and unnecessary expense. The successful negotiation will focus on more than just rent. By reducing risks and avoiding surprises, the frantic calls for help may be a thing of the past.

Part 11

9. Defaults and Remedies: The rights and remedies of the parties in the event of a default by the other are largely governed by the express terms and conditions of the lease. In many states, there is no comprehensive statutory scheme governing such rights and remedies. The parties should assure that the lease document accurately reflects their understanding as to what constitutes a default and what will be their respective rights and obligations following a default. There are many economic considerations triggered by the remedies afforded, and therefore it is imperative to limit the exposure to avoid expenses above and beyond what is reasonable in the marketplace.

 

10. Insurance and indemnity: Risk of loss and damage between landlord, tenant and third parties is managed and allocated by a combination of indemnification clauses and insurance requirements. A full understanding of the requirements imposed upon both parties, to fairly allocate those risks in conformance with each party’s risk management policies, will always help reduce exposure to expensive and unwanted problems. It is advised that the negotiating lawyer always consult with the appropriate risk management professionals to insure compliance with lease requirement in light of such policies.

 

Article blog – Part 10

7. Repair, maintenance and alterations: Every lease will address maintenance and repair of the leased premises and common areas, and should also address alterations to the premises. Typically, the tenant will maintain the premises (except the structure) and the landlord will maintain the structure, the remainder of the building (not occupied by a tenant) and any common areas. For alterations to the premises, the lease will allocate responsibility between the parties to provide appropriate controls over the types of acceptable changes. The tenant wants flexibility to accommodate its business, while the landlord wants control over any changes, especially involving the structure, exterior elements and building systems (such as HVAC, plumbing and electrical).

8. Compliance with laws: Compliance with applicable laws and ordinances is usually a boilerplate provision, but can be very costly if not properly negotiated. The lease should address who is responsible for making capital expenditures for structural alterations required by laws enacted during the term of the lease (e.g. installation of sprinkler systems or improvements providing access for the disabled). These matters can be substantial and, if they are required to be made by the tenant, may end up being of relatively little utility.

Compliance with laws relating to the specific business conducted from the premises should be the responsibility of the tenant, and should not be included in common area maintenance expenses. ADA improvements necessary within the interior of the premises resulting from tenant’s work should be the responsibility of the tenant. On the other hand, improvements to the common areas necessary for access by of disabled individuals should be the landlord’s responsibility.

Further, compliance with environmental laws is quite significant because of the extensive nature of improvements and attendant costs, which could include the potential for removal of asbestos or lead, responsibility for insuring compliance with environmental laws and indemnification for non-compliance. Leases typically include lengthy representations, warranties and covenants regarding tenant’s compliance with applicable environmental laws.  However,  the tenant should limit responsibility to noncompliance by the tenant, its agents, contractors and agents, as well as ask for the same limitations and rights as granted to landlord (landlord should be responsible for compliance unless caused by a tenant). The definition of “hazardous materials” should ensure that common business materials (e.g. copier toner, batteries, etc.) and normal cleaning supplies are excluded.

Article blog – Part 9

6. Assignment and subleasing: Landlords want to restrict tenant transfers to control the use of the property, to eliminate harmful competition between tenants (avoid disadvantageous mix and violation of exclusives), and to maintain the landlord’s right to negotiate the lease. The issue of “control” is usually the focal point on assignment and subleasing rights. This is particularly important to retail tenants, who need to assure compatibility with other tenants. The landlord may also argue that, in a project that is not fully occupied, a tenant remarketing its premises is a direct competitor.

The most common compromise is to prohibit the landlord from “unreasonably” withholding, delaying or conditioning its consent to a sublease or assignment. The law often implies a good faith standard, and provisions that purport to allow the landlord to withhold consent in its “sole, absolute, and unfettered discretion,” may be unenforceable. Tenants sometimes require the landlord to specify the reason for withholding approval and include corrective actions that can be taken to make the transfer acceptable. The landlord may be required to respond within a specified period of time following request for consent, with landlord’s failure to respond timely deemed to be consent. Another variation is to define all factors the landlord may consider to determine if it has acted reasonably.

Another landlord approach is to reserve a recapture right if consent is requested, which allows the landlord to exclude an unacceptable tenant, control competition with existing tenants and capture any upside in rents. The landlord may also recapture the upside potential by requiring that some or all of the “net profits” from the transfer to be paid to the landlord, and then the challenge is to define “net.” Typically, direct costs, such as brokerage commissions and tenant improvements, are recoverable, but sunken costs usually are not. A provision requiring the tenant to disgorge “all profits” may not be optimal, since the tenant would have no incentive to realize profits.

7. Repair, maintenance and alterations: Every lease will address maintenance and repair of the leased premises and common areas, and should also address alterations to the premises. Typically, the tenant will maintain the premises (except the structure) and the landlord will maintain the structure, the remainder of the building (not occupied by a tenant) and any common areas. For alterations to the premises, the lease will allocate responsibility between the parties to provide appropriate controls over the types of acceptable changes. The tenant wants flexibility to accommodate its business, while the landlord wants control over any changes, especially involving the structure, exterior elements and building systems (such as HVAC, plumbing and electrical).

 

Part 6 – Negotiating a favorable agreement

Before the parties begin negotiating the lease document, and before the lawyer is consulted, the design process typically has already begun. By the time the LOI is prepared, the parties usually have at least a preliminary space plan for an office lease or a site plan for an industrial or retail project. The basic scope and nature of the construction will have been discussed and an understanding of some sort reached. The negotiations should flush out the unstated assumptions and expectations of the parties and resolve points of conflict.

Negotiating the lease should not be difficult! In fact, many landlords recognize that providing “superior tenant service” begins by making the lease negotiation process as simple and efficient as possible, as long delays over minor details serve neither party. Increasingly, landlords are shortening the lease negotiation process through a system of alternate lease clauses used to substitute standard clauses as appropriate, to avoid having to write specific language each time an issue arises.

Part 5 – The Letter of Intent

For purposes of this article, the negotiation process begins with the Letter of Intent (or LOI), which can only be developed after the tenant understands its needs. The LOI represents a compilation of the many considerations that a tenant might have. All of the tenant’s needs and core requirements (both business and legal) should be considered when developing the LOI, as it is difficult to obtain the best result when important considerations are introduced late in the negotiation. Further, the LOI should be consistent with market conditions and what the particular tenant can attain in the current marketplace (i.e. Fortune 500 credit will normally be able to ask for more than a smaller tenant with local credit) and the LOI should be customized to properly reflect the same.

The LOI, once presented, becomes the basis for the negotiation and helps maintain a focus on issues not fully resolved between the parties. Even if non-binding, deviating from terms agreed upon in the LOI is difficult. Accordingly, the importance of initially addressing all significant items in the LOI cannot be overemphasized. For example: (1) the tenant’s negotiating leverage will be reduced if provisions such as options to extend or terminate, liability limitations, escalation and security deposit provisions, rights of first refusal, and other items of significance are not included in the LOI, and (2) it serves everyone’s interests to spend extra time on the details of the LOI to minimize misunderstandings during negotiations, together with the associated cost of attorneys and other professionals engaged by the parties. To preserve that the LOI will not be binding, the document should not only provide as such, but should further provide that it imposes no legal obligation to continue negotiations to reach agreement. Alternatively, the parties may be obligated to negotiate in good faith, and if no formal agreement is reached within a prescribed period of time, either party may terminate negotiations.

As a result, it is important to employ an effective method of tracking the progress made on deal points, while also assuring that the original points eventually are addressed. This has the added benefit of documenting the negotiation, which is useful to understand the intent of the parties and to draft language accurately reflecting all negotiated points.

Part 3 – the Process

The selection and acquisition of a facility for a company’s business is one of its most important decisions it will make, and it can mean the difference between profitability and failure. Commercial leases are made for the long-term, and the payments made under a lease often represent a significant portion of the business’ expenses. The total financial burden of rent, costs of tenant improvements and other lease charges can significantly impact the overall success or failure of a business. To reach the best deal, and to prevent costly disputes, it is crucial to negotiate a favorable and highly detailed agreement. Understanding all of the lease details will allow you to negotiate effectively and creatively, and will also keep you from being surprised by unfavorable or unfamiliar terms.

The process basically consists of site selection, business terms negotiation and document negotiation and drafting. To be successful, each component of the lease must be identified, analyzed, prioritized and negotiated. Also, the timing required to complete the lease transaction should not be overlooked. Ample time should be allowed and the participants should not permit themselves to be rushed through the process in the pursuit of unnecessary or arbitrary deadlines. Decision-makers and participants in the leasing process should be consulted early to determine the amount of time required for each step and a timeline should be considered allowing an orderly selection, negotiation and documentation process.

Identification of all business and legal needs, and subsequent prioritization of such needs, should occur at the very beginning to avoid losing sight of the most important issues. Identification is facilitated by each side asking itself a number of questions relating to their respective needs and attaching a level of importance and priority to such needs. A list of questions a tenant might ask is provided in the table below [See Table 1 – I will post this soon], however each party should consult qualified professionals to help ask the right questions and develop an understanding of their own business and legal needs.

Blog Series – Successful Lease Negotiations, part 2

Types of leases Leasing is a complex subject because there are so many different kinds of leases, and it is a field of law, which can change rapidly as market and general economic conditions require new approaches to addressing the parties’ rights and obligations in the transaction.

Most commercial leases are categorized according to whether the use is office, retail or industrial in character. Each lease category tends to have more of a focus on one area or another. For example, office leases typically include services provided by the landlord, including janitorial services, maintenance, repair and operation of building systems, elevators, utilities, air conditioning and security. Industrial leases usually involve few services, except maintenance and repair of any shared parking or landscaping for a multi-tenant project. Retail leases are generally similar to industrial leases, but they include operational concerns particular to the retail context, including use restrictions, signage and site plan issues. There are also considerable differences between multi-tenant and single tenant projects, and the structure of any lease will be highly influenced by whether the property involved is leased to a single tenant or is part of a larger project.

A “gross lease” is one that involves payment of a fixed rental amount without any additional charges for taxes, insurance, utilities, or other charges. True gross leases are typically used only for short-term tenancies of relatively small lease areas. A “modified gross lease” is one in which some, but not all, operating costs of the property may be passed through to the tenant, in addition to base rent. In some forms of modified gross leases, the charges that may be passed through are taxes or other expenses of the property only to the extent that they exceed an “expense stop” or “base year amount.” Modified gross leases often are also “full service leases,” because the landlord directly provides all janitorial and utility services to the leased space. Further, a “net lease” (also called “triple net”) requires the tenant to pay, in addition to base rent, the tenant’s proportionate share of all utilities, insurance premiums, real property taxes, and maintenance and repair expenses for the property.

Further, specialized leases have evolved to serve financing functions, including ground leases (separate ownership of land from building), sale/leaseback transactions (shifting risks and benefits of ownership to a third party), build-to-suit leases (capital for building construction designed by tenant supplied by landlord), synthetic leases (operating lease for financial accounting reporting purposes and a secured loan for all other) and securitized leases (structured and packaged so income stream can be sold to third party investors through the securities market, often as a pool of leases).

It is important to fully understand the type of lease transaction being negotiated, regardless of what it’s called, in order to effectively negotiate the deal.

Blog Series, part 1

Both landlords and tenants seek help to resolve a dispute that has arisen with their commercial lease because they signed a misunderstood or poorly negotiated agreement. This is especially true of less sophisticated tenants who, for whatever reason, have chosen to sign the landlord’s “standard form lease” with few, if any, changes. Additionally, inexperienced landlords often use a form lease without fully understanding the terms and conditions imposed upon them.

The potential for dispute in a commercial lease can result from many things; however, the focus of lease negotiations is often limited to rent, concessions and other economic considerations. As a result, many important issues are often overlooked; misunderstood or under-negotiated (even by sophisticated landlords and tenants) that could materially affect the long-term success of the deal and are often the reason for their calls for help.

Commercial leases are often called “living” documents, as they govern the ongoing relationship of the landlord who owns or manages a property and the tenant who operates its business on that property. A lease is like a partnership agreement because it provides the parameters of a business relationship, and unlike many legal documents, the real work of a commercial lease commences when the document is signed and the deal is done. Negotiating the best possible deal is done throughout the entire leasing process, from the initial decision to move forward through lease execution. There are many significant terms and conditions that should always be considered when negotiating the deal.  This article sets forth a few of the major lease provisions that landlords and tenants should focus on, but is not intended to serve as a substitute for consulting with a real estate attorney.

Rent: Just One Side of a Commercial Lease Agreement

My blogs for the next week or so will contain excerpts from an article I co-wrote for the ACC Docket, November 2010 edition, titled “Rent: Just One Side of a Commercial Lease Agreement.”  The discussion contained in the article was written for corporate lawyers, but applies to a much wider audience as it describes the importance of careful planning and analysis throughout the leasing process, and also emphasizes the need for the tenant to focus on each provision contained in the definitive lease agreement.  A successful lease negotiation focuses on more than just the base rental amount, as vital components of reducing a company’s occupancy costs include mitigating risks and exposure to unforeseen expenses, maximizing flexibility and operating efficiencies, and aligning the company’s real estate strategy with its overall business plan. 

I hope these postings will be enjoyable to read and informative.  Feel free to call or email, and we’ll show you why we’re Studley!

Negotiating the lease deal

It is amazing how often companies find themselves looking for guidance because an unpleasant surprise has come up during the term of their lease, with the vast majority of such issues costing them significant dollars (that wasn’t included in their budgets) in attorneys’ fees and costs to remedy the situation.  Often such surprises are due to having signed a poorly understood or poorly constructed lease agreement and could have easily been avoided.  This is especially true of smaller, less sophisticated tenants who, for whatever reason, sign the landlord’s “Standard Form Lease” with few, if any, changes. 

A lease is much like a partnership agreement in that it governs a business relationship that could last for many years.  When everything goes as planned, most leases will serve the parties well but the true test occurs when there are hiccups in the relationship.  If the lease has not been carefully drafted, a hiccup can become a major problem.  Tenants often lose sight of the fact that the “Standard Form Lease” represents the landlord’s wish list, and if not appropriately modified, will likely not serve their interests when issues arise. 

Most tenant rep firms do not fully protect their clients throughout the entire leasing process, as achieving a favorable deal includes the careful negotiation of the definitive lease agreement.  This is where our Studley team differs from the rest.  We’d be happy to show you why we’re Studley!

U.S. Commercial Real Estate Investors Turn Bullish on Office Sector for Acquisitions,

U.S. Commercial Real Estate Investors Turn Bullish on Office Sector for Acquisitions, According to Latest PwC Real Estate Investor Survey™

NEW YORK, Dec. 20, 2011 /PRNewswire/ — As 2011 comes to a close, commercial real estate investors continue to seek buying opportunities with the office market gaining increasing interest, despite a mixed bag of improving commercial real estate fundamentals, according to the fourth quarter 2011 findings of the PwC Real Estate Investor Survey, released today.

According to the report, buying opportunities beyond the core markets remain tricky due to a protracted recovery outlook for both the U.S. and many secondary markets.  Surveyed investors cite that commercial real estate continues to offer attractive yields compared to alternative investment vehicles.  In the office sector, investors are bullish regarding their prospects for tenant retention and expect office rent growth in many markets in the coming year.

Ty Gives His Views: Experience Matters.