Over the last 4 years I have negotiated over 100 commercial leases for office, retail and industrial properties in San Diego County. In doing this, I have experienced a wide variety of successful and unsuccessful strategies and would like to share my experiences as a resource for landlords and tenants.
I have to provide the following disclaimer: I am not an attorney and this article is not intended as a substitute for advice from the appropriate legal, zoning, financial, construction and/or tax professionals. This information is provided for educational purposes only and is made without warranties or representations.
The first step in successfully negotiating a commercial lease is to understand the lease structure. The most common commercial leases are:
Gross Lease – The tenant/lessee pays 1 bill each month. The amount paid covers the base rent with all other associated costs being paid for by the landlord/lessor. Landlord responsibilities under this type of lease include: building maintenance, utilities, insurance and property taxes. This type of lease is most commonly used for office space.
Modified Gross Lease – The tenant/lessee pays for the base rent as well as the utilities provided to their unit within the property. The landlord/lessor pays all other operating expenses of the property. This type of lease structure is used for a wide variety of commercial properties including office, retail and industrial space.
NNN Lease – Under the triple net lease structure the tenant/lessee pays the base rent as well as their pro rata share of all the operating expenses for the property. The landlord is responsible for maintaining accurate accounting of the property’s operating budget and reconciling the NNN expenses on an annual basis. This type of lease structure is most commonly used for retail shopping centers and large multi-tenant industrial properties.
There are several other types of commercial lease structures including: percentage leases, ground leases, double net leases, full service gross leases and others. However, the three types listed above are the most common and used on 90%+ of commercial lease transactions.
From the landlord’s perspective the NNN lease is the most attractive structure because any increase in the properties operating costs is passed on to the tenants. However, there is an administrative burden associated with maintaining an accurate NNN budget, so this type of commercial lease may only be appropriate for large properties.
From the tenant’s perspective the Gross Lease is the most attractive as it provides the most certainty in projecting the costs associated with leasing a property. That being said, the structure of the lease is generally determined by the landlord and if a tenant tries to demand an unfavorable lease structure it can cause a negotiation to fail.
There are a variety of concessions a landlord can provide in order to incentivize a tenant. The most common concessions include:
Discounted Rent – The most straightforward lease concession is discounted rent. With this concession the tenant will pay a discounted amount of base rent for all or a portion of the lease term.
Rental Abatement/Free Rent – This is the most common lease incentive. Here, the tenant will not be required to pay the base rent for a predetermined portion of the lease. Usually, the tenant will still be required to pay for utilities or NNN fees during the abatement period.
Tenant Improvement Allowance – This is the most expensive concession as it requires an immediate capital outlay on behalf of the landlord. With a tenant improvement allowance the landlord will pay for modifications to suit the needs of the tenant. The allowance is typically negotiated on a “Dollars Per Square Foot” basis and the length of the lease as well as the strength of the prospective tenant are key determinants.
Annual Rent Increases – Inflation is a real thing and for this reason the amount of base rent paid needs to increase each year in order for a commercial property to remain profitable. In my experience the average annual escalation to base rent is 3% however it can range from 2-5% each year.
Lease Extension/Renewal Options – At the end of the initial lease term the tenancy will typically revert to a month-to-month arrangement with either party being able to cancel the lease by providing 30 days written notice. In order to avoid uncertainty tenants will often request predetermined options to extend the lease upon expiration of the initial term.
Signage Rights – In a retail setting there is a variety of signage options. These include suite, monument, directory and building signage. It is best for both parties to negotiate the signage rights at the time of the initial lease to avoid conflicts in the future.
Parking – Tenants can have a broad range of parking requirements depending on the type of business use. Lease terms associated with parking include: reserved parking, unreserved parking, the ability to park vehicles overnight, etc.
First and foremost is having your financials in order. By presenting a professional image with your initial proposal to the landlord you dramatically increases your chances of a successful negotiation. It is recommended that you include the following with your letter of intent: 2 years tax returns, current bank statements, a complete lease application and links to your companies website.
Pick one category of concessions. If you submit an offer asking for reduced rent, free months of rent and a tenant improvement allowance the landlord is likely to feel that the tenant is not serious about the space and may not respond at all. By picking one category of concessions you narrow the scope of the negotiation and increase your likelihood of making a deal.
Considering taking the space “AS-IS”. If you have the financial capabilities to complete your own tenant improvements, do so.This allows you to get things done on your schedule and gives more discretion in the quality of materials used. By taking the space “AS-IS” it has the least immediate financial impact on the landlord and creates the strongest position for negotiating a discount on the rent.
Utilize a leasing broker. While this tip may seem self-serving (I am a leasing broker) the most egregious negotiating mistakes I have seen are committed by landlords who are unrepresented. Utilizing a broker creates a layer of insulation in the negotiation. Furthermore, a broker will likely have contact with multiple prospective tenants which will increase the landlord’s bargaining position.
Have the tenant complete the improvements. By having a new tenant invest in improvements to the property they now have “skin in the game” as most improvements cannot be removed should the tenant vacate the space. Furthermore, having the tenant spend money to renovate the space creates a significant cost should the tenant consider moving. This strategy is particularly useful when it comes time to negotiate lease renewals.
Stagger the months of free rent. A common mistake landlords make is having all of the months or rental abatement occur at the beginning of the lease. For, once the base rent kicks in the tenant may be unable to perform and the landlord will have tied up the space for months without any financial return. A better strategy is the apply free months periodically(for example: months 2, 13, 25). The tenant then has to perform under the terms of the lease for an extended period prior to receiving their concessions.
A commercial lease is an asset to both a tenant and a landlord and both parties should carefully consider how each term will affect their present and future bottom line. If you have questions or would like assistance on a specific transactions reach out to me through the contact page.