Once you've found suitable commercial real estate and you and the landlord have agreed on the key features of the lease, such as how much rent you'll pay and how long the lease will run, it's time to formally spell out your deal in a binding, written lease. Most important? Head into the lease negotiations understanding the meaning of the landlord's lease clauses. A thorough understanding of common commercial lease clauses will help you avoid hidden, onerous traps. It will also help you bargain for modifications in your favor.
The list below introduces you to the most common lease clauses.
Leases generally begin by naming the landlord and the tenant, in a clause entitled "Parties." Or, the clause may be entitled "Landlord and Tenant," or "Lessor and lessee" (the landlord is the lessor and the tenant is the lessee). Although you might not think so at first, it's important to look at these names carefully. For example, if you are a corporation or an LLC, you'll want to make sure that your name on the lease is your legal name, such as "Able Investments, LLC," or "Macro Industries, Inc." An error in the way you or the landlord is identified can have serious repercussions. If you are an LLC or corporation and you list your personal, not corporate name, you may become personally responsible under the lease (avoiding personal liability is probably one of the reasons you incorporated your business or became an LLC).
Somewhere near the beginning of your lease, often right after the Parties clause, you'll see a clause that identifies the space that you'll be occupying. This clause is often titled "Premises." If you're leasing an entire building, the clause should simply give the street address (and should describe any outbuildings or lots that come with it). If you're leasing less than an entire building, you and the landlord need to describe the space more precisely. In particular, if you will have access to storage rooms, conference rooms, parking, kitchen facilities, and the like, you should spell this out.
The Use Clause and Exclusive Clause
A use clause limits how you'll use the rented space. The limitations can be as broad as what business you'll conduct there, as narrow as what specific services or products you'll offer, or as nebulous as the quality level of your operation. Landlords can impose use restrictions for any of these reasons:
- The landlord has promised other tenants that no one will compete with them.
- The landlord is worried about liability if you conduct certain kinds of businesses.
- The landlord has a personal aversion to certain kinds of business activities.
In general, you'll want to avoid strict restrictions on your use of the rented space. Most of the time, you'll count yourself lucky if the lease handed to you by the landlord does not include a use clause.
An exclusive clause is a promise by the landlord that only you and no one else in the mall or building may engage in a particular type of business or carry a certain type of merchandise. (Naturally, other tenants will have use clauses that prevent them from conducting business activities that would violate your "exclusive.") Typically, only powerful "anchor" tenants get exclusives.
Near the beginning of the lease, you'll see a clause entitled "Term." This clause describes the length of your lease and specifies the starting and ending dates. You may be tempted to cruise right through it -- after all, if you want a five-year lease and the Term clause gives you five years, where's the complication? Alas, there's more than one tricky wrinkle, and they're apt to be hidden and dangerous. For example, some leases start as of the date the lease is signed, even though you haven't conducted business for even a day. Though you might not be responsible for rent right away, you will be responsible for other obligations in the lease, such as the requirement that you carry insurance. Done properly, leases should have many "start" dates, corresponding to when you can enter to set up, when your rent is due, when you become responsible for securing insurance, when you can open for business, and so on.
For most small businesses, the amount of the monthly rent obligation is a very important issue. It's important to look carefully at the landlord's lease clauses to see whether your rent estimates will pan out and to determine any new costs or savings, such as:
- expenses that you didn't anticipate -- make sure you understand which parts of the landlord's operating costs will be passed-on to you
- savings that may make it possible to shoulder other expenses -- for example, the landlord may offer a "tenant improvement allowance," which you will use to get the space ready for your operations, or
- issues that you want to renegotiate, such as the landlord's expectation that the rent will increase by a certain amount on a stated date.
Your landlord may ask for a security deposit to assure that cash will be available if you fail to pay the rent or don't make other payments required under the lease. Unlike residential landlords, who in many states may not ask for more than two months' rent as a deposit, commercial landlords may demand whatever amount they think they need as a cushion to cover rent and other tenant financial obligations.
Or, instead of a security deposit, your landlord may ask for a "letter of credit" from your bank, in which the bank puts aside an agreed-upon amount of your funds for use by the landlord should you not carry-out your financial obligations.
Improvements and Alterations
If your new space will have to be customized to fit your needs, a big chunk of your lease should address this issue. You and the landlord will have to reach an agreement about who does the design, who does the work, when it gets done, and who pays for it. And if you're going to occupy space in a building not yet completed, you'll want to be sure that you pay for as little of the finish-up work as possible.
Maintenance, Utilities, and Code Compliance
The landlord's lease will undoubtedly contain a Maintenance clause that concerns your duties to care for your own rented space (or for the entire building, if you are the sole tenant). If you're a tenant in a multi-tenant building, you and the landlord will also have to settle on how the utilities will be billed and paid for, so you'll often see a Utilities clause near the Maintenance clause in the lease. Finally, the landlord may expect you to keep the building "up to code" -- whatever that means (it often isn't clear), in a lease clause sometimes titled "Compliance" or "Compliance with Laws."
Parking, Signs, Landlord's Entry, and Security
You're likely to find several clauses in the lease that concern practical understandings you have with your landlord, about such things as parking and business signs. As you negotiate these clauses, you and the landlord will be trying to smoothly integrate your needs to run your businesses wisely. Although these clauses may not pack the punch of a Rent or Maintenance clause, they can be very important to a successful and convenient tenancy.
Several kinds of insurance are available to cover the risks of leasing commercial space, including property and liability insurance, rental interruption insurance (this covers you if your business is unexpectedly interrupted, as would happen after a natural disaster), and leasehold insurance (this coverage protects you if your lease is canceled due to circumstances beyond your control and you have to rent elsewhere at a higher rent). You'll need to evaluate each type of insurance coverage in the context of your lease and your landlord's requirements, your business needs, and the property -- and negotiate accordingly. An insurance broker can help too, especially when it comes to choosing adequate levels of coverage.