Heavily-Negotiated Provisions of Commercial Leases
We will briefly discuss a few of the common provisions that we see negotiated in leases.
Our firm is frequently retained to draft, review, negotiate, and advise our clients on the impact of commercial lease agreements. In these leases, there are certain provisions that get negotiated more than others; and, as with any contract negotiation, you must often ‘give’ on certain areas in order to ‘get’ on others. Ultimately the negotiating leverage of the parties will typically depend upon several different factors, such as size of the rented area; term of the lease; brand recognition; lease market conditions; and duration of business. For example: if a national chain pizzeria desires to lease a new restaurant for 10 years in a shopping center that is 60% vacant, chances are the tenant will have the upper hand in the negotiation. In contrast, let’s say that a brand new coffee shop wants to take a small space at the end of a commercial plaza on a busy street, and only wants a 2 year lease because they’re not sure if they’ll be able to get off the ground; the landlord will definitely have the negotiating advantage in that scenario.
This article will briefly discuss a few of the more common provisions that we see negotiated in leases and how they impact the parties to them. It will be the first in a two-part discussion.
1. Pass-Through Expenses and CAM Fees
Gross vs. Net Leases
With the ownership of a commercial property comes many expenses. Principally, there are property taxes, property insurance, and property maintenance expenses. A commercial landlord may choose to absorb these expenses as a “cost of doing business” and set their tenants’ rental obligations as a flat monthly fee. This is what’s known as a “gross lease”—the monthly rent is a flat fee that includes any expenses that the landlord desires to pass through to their tenants. By way of example, most apartment leases are structured this way. In contrast, a landlord may choose to pass on these expenses to the tenants, in proportionate share—in addition to a monthly base rent. This is what’s known as a “net lease”. Depending on the particular costs being passed through to the tenant, the lease may be structured as a single (net), double (net-net), or triple (net-net-net) lease. Single would be where the tenant pays for one of the three typical pass-through costs (taxes, insurance, or maintenance); double would be two of the pass-through costs; and triple would be all three of the pass-through costs.
Common Area Maintenance—or “CAM”—fees are a routine part of almost every commercial lease. CAM fees are the landlord’s way of passing through costs to the Tenant for maintenance of the parking, sidewalk, lobby, and other common areas which may be applicable to the leased premises. CAM Fees can be fixed, or variable.
2. Base Rent
Typically, the base rental amount for a leased space is calculated off of a per-square-foot (PSF) price. More desirable locations will have a higher PSF price than less desirable ones. Also taken into account is the age, furnishings, finishes, technology, and amenities of the building. Office spaces in particular are often ranked using a Class designation (i.e., Class A, Class B, and Class C). Once determined, the PSF price is multiplied by the leasable area to arrive at an annual rental amount. Divide this sum by 12 and, voila, you have your monthly base rent amount!
In certain circumstances, a landlord may choose to set a tenant’s monthly rent based upon a base rent amount, plus a percentage of the tenant’s monthly sales volume once it exceeds a certain established threshold. This is what’s known as a “percentage lease” or “variable rent lease”. If the tenant’s business is doing well, they pay more in monthly rent; likewise, if they are having a down month, the monthly rent will be lower. In either case, the landlord may also still seek to charge the tenant for their proportionate share of taxes, insurance, and/or maintenance costs.
At the end of the day, base rent is dictated by the market. If there is a shortage of office rental space in your area, and you are an insurance broker, you can expect to pay more in base rent. Likewise, if there is an abundance of new shopping plazas that are sitting vacant near downtown, and you are a retail store looking for a downtown location, your base rent will probably be competitive.
3. Maintenance and Repair Obligations
One big question in a commercial lease is: who’s going to pay for repairs? And, which ones? If a tenant is taking a fully-furnished retail space, they may not want to be responsible for repairs to major components of the premises, such as the subfloor, roof, plumbing, electrical, or HVAC system (beyond changing air filters). However, if a large tenant is doing a build-out, and they are the ones installing these building components, the landlord may insist that the tenant maintain them. It is also important to consider the age of premises in this scenario as well.
Often a good compromise that we see parties using is an overall maintenance cap for a tenant, whereby they are responsible for general maintenance and repair of the leased premises, but not to exceed X amount (unless the repair is necessitated by their negligence or intentional act). This is usually used in conjunction with a requirement that the tenant contract with a licensed HVAC provider for regular preventive maintenance of the system.