Suite Deal

by Alice Devine

  When operating-cost savings are passed directly or indirectly back to the tenants, the tenants can be rewarded for choosing a sustainable building. Some landlords add green or other capital improvements to their buildings by incorporating lease language that allows owners to pass through amortized capital expenditures intended to reduce operating costs or improve the utility, efficiency, or capacity of any building system.

  Common Objections and Concerns

  While tenants negotiate many facets of operating expenses and taxes, the most common request is that the operating costs be capped at a certain increase per year. In addition, tenants will often want to negotiate various aspects of operating expenses, usually ones that have the ability to be large-ticket items: roof membrane replacements, Americans with Disabilities Act compliance, improvements intended to make a building more efficient, and so on. Landlords typically address these issues one by one, and if not capping expenses, they may make modifications to individual line items. With respect to capital costs required to meet government regulations, often landlords explain that these costs are typically beyond the landlord’s control and that such improvements are not necessarily adding value to the building (for the landlord’s benefit), but are simply code compliance.

  A Yen for Legalese?

  Commercial Lease Law Insider (commercialleaselawinsider.com) is penned for managers, owners, attorneys, and leasing professionals. This excellent newsletter explains lease clauses and solutions using real-life examples. Paid subscription and free e-alert both available.

  Clauses About Building Systems and Integrity

  The next set of clauses deals with language intended to protect the landlord’s real property, including the building systems such as HVAC, fire sprinklers, plumbing, and so on. Procedures regarding repairs, if needed, are also discussed. Although a tenant may not realize the benefit of these clauses, they serve to protect both the tenant and the landlord and ensure functioning building systems.

  Who Says Latin Is a Dead Language?

  ad valorem: “according to the value”

  bona fide: “in good faith,” implies sincere good intentions regardless of the outcome

  caveat emptor: “let the buyer beware”

  de facto: “from the fact,” common in practice, but not established by law

  force majeure: OK, you’re right, it’s French, not Latin, and it means a “superior or irresistible force” or an event or effect that cannot be reasonably anticipated or controlled (think lightning, earthquakes, and hurricanes)

  quid pro quo: “this for that” or “something for something”

  subrogate: from the Latin subrogatus, “to elect as a substitute,” to put something or someone, such as a second creditor, in the place of another with regard to a legal right or claim

  Alterations

  Alterations, as opposed to tenant improvements, usually refer to construction or improvements after tenants have taken occupancy of the space.

  The alterations clause protects landlords against liability for mechanic’s liens, building code violations, uninsured contractors, code and environmental violations, among others. Furthermore, certain alterations can adversely affect the structure of the building and/or the performance of critical building systems such as HVAC, electrical, plumbing, and other mechanical systems. Landlords are usually concerned with protecting the integrity of their building systems, which support a functioning, quality operation. As an example, if a tenant constructs a private office without the landlord’s knowledge, the HVAC systems (and other electrical and fire systems) could be compromised. In addition to the potential for legal claims relative to construction, landlords are concerned with disruptions to other tenants.

  Common Objections and Concerns

  Tenants might say they do not want to seek the landlord’s approval for every improvement they make and may cite an innocuous chore, such as painting the office kitchen. Some landlords approach this by asking the tenant to notify the landlord (in writing) of cosmetic improvements but then insist on approving more substantial improvements. Landlords explain that even something as simple as moving a wall can impact heating and air conditioning and fire sprinklers—systems involved in providing a safe and functional space.

  Last, alterations clauses might contain a definition for a trade fixture as opposed to real property improvements. The clause sometimes makes tenants liable for any damage caused by the removal of a trade fixture. Occasionally an issue will arise as to whether a particular item that the tenant wants to install (such as customized, adjustable shelving) is a trade fixture that can be removed by the tenant or if it becomes part of the real property that reverts to the landlord at the lease end. This technical issue should be discussed with counsel.

  Damage and Destruction

  This clause typically addresses the procedure and time frames for repair in damage and destruction situations. Whether because of a localized issue (fire, for example) or an area-wide issue (an earthquake or hurricane, for instance), the clause outlines a process and the respective obligations of the landlord and tenant. The burden falls mostly on the landlord, even though the various scenarios are oftentimes caused by outside influences beyond the landlord’s control.

  Common Objections and Responses

  This clause can be extremely difficult to negotiate because both parties have a risk of loss and impact to their respective businesses in a damage situation. Tenants are concerned about having their businesses closed and will want to know how long repairs will take, so they might object to the period of time allowed for reporting and making repairs. On the other hand, landlords must have rental income to pay their mortgages and other expenses. Accordingly, landlords need to know that they will have the opportunity to rebuild and restore their premises so that the leases remain in effect. Also, landlords may want the ability to terminate leases if they do not have significant funds to repair the damage or if repairs do not make economic sense.

  Call me Debbie Downer, but lease negotiations involve imagining what bad things might happen (in order to protect your downside). I have found that explaining a scenario often helps tenants to understand the rationale behind requirements, time frames, and language. I might say, “Let’s suppose an earthquake strikes. Many buildings are damaged. In a race to repair, dozens of owners submit permits for approval. The city inspector becomes overwhelmed, which lengthens the review process. So it may take us weeks to have a permit approved before we can pick up a hammer. Also, we’ll be working with insurance companies and doing our best to accommodate tenants. Although conservative, that’s why the process may extend to several months.” A description of that sort helps clarify clauses that the tenant perceives as onerous. Because sometimes, what you imagine will go wrong, does.

  Clauses About the Landlord’s Control of the Property

  The next set of clauses has to do with the ability for the landlord to maintain flexibility and control, primarily in terms of leasing. A lease creates an encumbrance—albeit one that the landlord is usually happy to have—with regard to space. There’s a delicate line between providing tenants with support for their businesses and retaining the landlord’s ability to maintain the building’s value and operation.

  Use

  Use clauses deal with how the tenant uses the space, often drawing parameters about the type of business that may be conducted in the space. Leases contain this clause to ensure that the tenant does not use the premises for any purpose that is dangerous, poses issues for other tenants, threatens the integrity of the building or any of its systems, is illegal, and so on.

  Fair Enough

  When tenants complain that holdover rates are too high, the leasing representative often responds, “Of course the holdover rent is unreasonable—it is meant to be. We want you to make a decision.”

  Common Objections and Responses

  What response should you expect from the tenant on
the use clause? Hopefully nothing. If a tenant resists this language, leasing personnel should look closely. What does the tenant have in mind? Any issue with this clause should prompt a heart-to-heart conversation between the landlord and tenant.

  When tenants raise issues, you can find out what worries the tenants and address their specific concerns. As an example, commercial tenants may request a specific use such as storage or warehousing inventory.

  What response should you expect from the tenant on the use clause? Hopefully nothing. If a tenant resists this language, leasing personnel should look closely. What does the tenant have in mind? Any issue with this clause should prompt a heart-to-heart conversation between the landlord and tenant.

  Assignment and Subletting

  This clause deals with the possibility of tenants subleasing their spaces or assigning their leases.

  Common Objections and Concerns

  Some tenants assume that so long as they pay rent, subleasing or assigning their lease doesn’t have much impact on the landlord. As such, the tenant may have a difficult time understanding why a landlord wants to approve a subtenant or why the landlord should share in any subletting profits. Tenants are concerned about keeping the flexibility to sublease their spaces or assign their leases in the event they don’t need (or can’t afford) their leased spaces.

  As a practical matter, though, subleases can cannibalize a landlord’s marketing efforts. For example, when tenants elect to assign or sublet their spaces, they may compete with the landlord for existing tenants that want to expand or prospective tenants who relish the lower sublease rate. By subleasing, tenants can undercut landlords’ rental rates and force the landlords to charge lower rates than they would have otherwise. Then, landlords face the awkward situation of explaining to prospective tenants why they charge more rent for the same building and justifying how a direct lease is more beneficial than a third-party sublease.

  In addition to blunting a landlord’s competitive edge, sometimes a sublease assignment can leave the landlord with a financially unstable or less-than-desirable subtenant. While the tenant is still primarily responsible for the lease and rent, should the tenant default, the landlord could be looking to the subtenant to satisfy the lease obligations. What if the accounting firm you leased to decides to sublet to a start-up dog walking service? A proposed subtenant may impose on and excessively burden the building services or may not have a compatible use of the property. What if the law firm that rented the space subleases to a twenty-four-hour delivery company?

  My tenant with sublease space used our property’s leasing flier with its pricey color photograph of the building, bulleted list of amenities, and a floor plan outline and map for its own sublease advertisement. We’d created the full-color piece for our direct space on our dime. Adding insult to injury, the tenant’s broker then called me a “turkey” in front of my own tenant when I explained that our marketing materials weren’t to be used for others’ subleasing purposes. The last thing I wanted was to compete with my own tenant. This uncomfortable situation underscored the need to pay close attention to sublease language.

  Relocation of Premises

  Relocation clauses allow landlords to move tenants throughout the building (or project) from time to time during the lease term, subject to some conditions for the relocated space. At office parks with more than one building, a landlord might have the right to relocate tenants to any of the buildings within the campus. The relocation right is important because of the leasing flexibility it grants landlords, particularly when accommodating tenant expansion or large prospective tenants.

  Common Objections and Responses

  Tenants want to eliminate this clause. They do not like the unknowns of potential relocations, as moves are inconvenient and disruptive to business.

  Many landlords try to negotiate concessions to this clause rather than delete it entirely. But size matters. Large tenants can be successful in having this clause deleted or significantly modified, because relocation can be cost prohibitive and physically implausible for them. Concessions to smaller tenants might include that the relocated premises are comparable to the existing suite in terms of distance from elevators, views, and so on, and some certainty that the tenant’s rent will not increase (even in the event that the relocated premises are slightly larger).

  Surrender and Holdover

  The surrender and holdover clause deals with what happens in the event that a tenant does not leave the space in an orderly or timely manner. If tenants stay beyond their lease expiration date, the holdover rent might be twice as high as during the last month of the lease term. As a general rule, tenants control whether or not they will be in holdover status. They may have deferred their lease renewals, not calculated their move timing correctly, or simply failed to reach a decision with regard to their spaces. In these instances, landlords usually need all the leverage they can get to encourage tenants to reach a decision. Will they stay or will they go?

  Holdover clauses can also hold tenants responsible for damages (like opportunity cost) resulting from not leaving the space; had the tenant vacated on time, the landlord may have been able to release the space. The holdover section can provide for the tenant to pay the landlord any lost rent, costs, or other lost profits caused by the tenant’s staying in the space and hindering the landlord’s ability to lease to a new tenant.

  Common Objections and Concerns

  Tenants sometimes protest that “the holdover rate is prohibitively high.” Tenants also try to eliminate the damages paragraph.

  Of course the holdover rent is unreasonable—it is meant to be. Landlords set high holdover rates to encourage timely decisions with regard to space. In addition, holdover rates are artificially high because a landlord does not want the rate to be commensurate with the market rate at the time of lease expiration, as that would reduce the incentive for the tenant to make a decision. Landlords could potentially end up with month-to-month tenants and have their leasing hands tied, unable to make long-term commitments to anyone.

  Lease Clauses: Extension Rights, Right of Offer, Right of Refusal, and Expansion Rights

  The following section covers clauses that deal with tenant rights and space encumbrances. Generally speaking, these rights benefit the tenant and limit the landlord’s flexibility with regard to leasing space. When negotiating a lease, a five- or seven-year term can seem an eternity. That longish horizon can lead negotiators to grant such rights to tenants, leaving the administrative burden for another day (or individual). Leasing agents and landlords, however, often come to rue these clauses because a complicated web of rights and encumbrances can so burden a space that it becomes challenging to lease. As such, many landlords learn to grant these rights judiciously.

  To a large degree, rights are a function of the market at lease signature. In soft markets, landlords are often forced to grant a myriad of rights to a tenant, simply because competitors do. In tight markets, landlords can be stringent. Regardless, paying attention to the details, even when rights are granted, can make a difference to the landlord.

  A word to the wise: understand and confirm all the existing rights of current tenants before discussing lease rights with a prospective tenant. Many landlords, property managers, and leasing professionals rely on software with color-coded floor plans and rent rolls to illustrate existing rights. Because new rights will be subordinate to existing rights, landlords need to be sure they have offered space in the appropriate priority and under the prescribed terms.

  Generally speaking, these rights benefit the tenant and limit the landlord’s flexibility with regard to leasing space.

  Extension Rights

  This clause grants the tenant a unilateral right to extend its lease term, usually with written notice to the landlord. Oftentimes, the rent for the extension term is set at fair market value (FMV) at the time of the extension, meaning the typical market rent for similarly sized spaces, b
uildings, and amenities. The notice period can range between three and eighteen months and is usually a function of the square footage leased. Larger tenants have a longer notice date, presumably because a bigger space takes longer to rent, complete tenant improvements for, and so on.

  Common Objections and Concerns

  Tenants generally try to negotiate a percentage, such as 90 percent (or 95 percent) of FMV. Tenants argue that they are a known, rent-paying quantity to the landlord and, as such, should enjoy a rent discount. Second, tenants ask that notice periods be shortened.