Real Estate Newsletter
Waste and Mismanagement
Commercial leasing, as the name implies, is a specialized area of legal practice involved with the rental of business and commercial property, usually for extended periods of time. In virtually all cases, both commercial and non-commercial tenancies are controlled by the same set of landlord and tenant statutes. Commercial leasing is a separate field of law due to the unique demands of long-term business use for both the owner/lessor and the tenant/lessee.
Most residential leases, for example, are for a year or less. This gives the owner of residential rental property flexibility to increase or decrease rents as market conditions, taxes, and expenses change; at most, the owner is locked into a bad deal for a year or less. And while few residential renters are pleased if they lose their lease and are forced to move, the consequences are usually limited to the inconvenience and expense of finding and moving to another apartment.
The same cannot be said of the parties to an extended commercial lease. Finding and maintaining a good location is critical to the success of any business, and once established and successful, the businessperson will desire to stay over the long term. One year would be a relatively short term for a commercial lease, and they may commonly run to terms of five, ten, or twenty years, often with provision for subsequent renewals. Obviously, a commercial lease needs to be flexible enough to adapt to changing conditions. One of the central issues in negotiating a commercial lease will be balancing the tenant's desire for certainty on issues such as rent with the landlord's desire to be able to increase rents based on increased costs or even an improvement in rental market conditions. Provisions found in a commercial lease might include the following:
- The landlord may want to include a rent-escalator clause, which would increase rents to match inflation or average rents in that particular market. In some cases, rent may be adjusted based on the tenant's income. A common formula is to increase rent annually based on a percentage increase equal to the increase in the local consumer price index for the preceding twelve months.
- The lease will specify which party is responsible for providing services and utilities, such as electricity, heat, water, snow plowing of the parking lot and sidewalks, trash pickup, and custodial services.
- Generally, the landlord will want a provision allowing an adjustment in rent to reflect increases in taxes, utility costs, and similar expenses.
- A landlord who rents out space for use as a bookstore generally will not be happy to wake up one morning and find that the space is now being used as a machine shop. Commercial leases will therefore generally prescribe uses to which the property can be put and will place limits on subleasing or assignment of the lease.
- In multi-tenant buildings, parking and storage-space issues will frequently be addressed, as will issues involved with access to the building, building hours, and the like.
- A substitution clause may be included to allow the landlord to move the tenant to another space in the same building, provided the space is reasonably equivalent and the landlord pays the costs of the move. This is designed to allow the landlord to maximize occupancy of the building by accommodating future tenants with a need for large blocks of adjacent space.
- If the rental space needs to be modified for the tenant's use, the landlord will frequently want to maintain control over any modifications. Often, a build out allowance is provided in the lease as an inducement to new tenants.
Another issue that arises frequently in commercial leasing is personal guarantees. Many commercial leases involve business entities such as corporations. When a long-term lease is involved, the lease may be one of the largest obligations the business assumes. If the business is a smaller or start-up operation, the landlord owner will often want the principal shareholders or owners of the business to personally guarantee the obligation. If the principal shareholders or owners execute personal guarantees, they will be liable for the entire amount of the rent if the business fails. The goal of the business tenant, of course, is just the opposite. The business would prefer to keep the lease obligation a purely corporate obligation, so that if the business fails the owners can close up shop and walk away without personal liability.
Whether a personal guarantee is appropriate, depends on the specific circumstances of the commercial lease. The lessor/landlord will usually want a personal guarantee, while the tenant usually will not want to sign one. This question is often resolved by the relative economic needs of the parties. If the tenant wants the space more than the landlord needs a tenant, the tenant may have to acquiesce and sign a guarantee. Often this issue is one on which compromise is possible. For example, the business owners may guarantee only the first few years of a multi-year lease in the hope that the business will become a success.
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