A Commercial Retail Landlord’s Checklist10/23/2017 | By: Scott M. Smiler, Esq. | GDB 2017 Fall Newsletter
You’ve finally found a tenant willing to lease your space and can now pivot to drafting the lease. Here are some points you should consider when negotiating with your tenant.
Renewals: From a landlord’s point of view, it is best not to grant the tenant a renewal option. Since most renewal options are one-sided in favor of the tenant (i.e., it is the tenant who unilaterally decides whether to exercise the renewal option, not the landlord), it’s preferable to level the playing field and remove the renewal option in its entirety. Certainly, both parties can agree to extend the lease without an express renewal option. However, most tenants, especially if they are making a significant investment into the space, insist upon a renewal option. In such cases it is advisable to limit the number of renewal options and the length of each renewal and also to provide that the tenant waives its renewal option if the tenant defaults under the lease.
Most important to consider is what rent to charge during the renewal option. Most tenants prefer to continue the same annual increase formula that was used during the initial term. However, from a landlord’s perspective, it is often difficult to predict the fair market rental value after the expiration of the initial lease term. Therefore, a landlord may consider some alternatives for rent escalation during the renewal term, such as a percentage increase based on the actual increase in the landlord’s operating, maintenance and insurance expenses, and real estate taxes, with a minimum increase. Alternatively, a landlord could engage the services of commercial real estate brokers to opine on the fair market rent. The formula is limited only by your imagination, though it should be agreed upon by the parties at the outset of the lease.
Additional Rent: Most commercial leases obligate the tenant to pay a portion of various building-related expenses in addition to the monthly base rent, commonly referred to as “Additional Rent.” Additional Rent is a catch-all term for all other payments and charges and may include the tenant’s share of real estate taxes, common area maintenance, operating expenses, security services, sprinkler services, fire monitoring services and other incidental charges. However, tenants only pay their proportionate share of these expenses. Accordingly, if the building is only partially rented, the landlord will remain responsible for the proportionate share of these expenses attributed to the vacant space. It is also important to remember that most commercial leases only obligate the tenant to pay its proportionate share of an increase in real estate taxes over the base tax year. Therefore, the landlord is still responsible to pay a bulk of the real estate taxes (i.e., the base tax).
Security Deposit: The security deposit can take the form of a letter of credit, but most often commercial landlords request cash in the amount of two to three times the monthly base rent. Therefore, when the rent increases, the amount of the security deposit must increase as well. Since most rent tends to increase annually, in lieu of an annual increase in the security deposit, the landlord may find it more convenient simply to request that two to three times the rent in the last year of the lease be tendered upon signing.
Guaranty: If the tenant is a corporation or a limited liability company, it is preferable from the landlord’s perspective to obtain a full personal guaranty from an individual who is an owner or affiliated with the tenant and who has a substantial financial worth. However, most tenants request a limited “Good Guy” guaranty. This guaranty provides that the guarantor can be released from all or part of his/her personal obligations if the guarantor is a “Good Guy,” which traditionally means that all arrears are brought current, the tenant provides the landlord with advance written notice of its intended vacancy date, and the tenant actually vacates the space by such date. A longer notice period is more beneficial to the landlord as it will provide the landlord with more time to find a replacement tenant.
Even if there is a limited “Good Guy” personal guaranty, the entity that is the tenant remains responsible for the tenant’s obligations for the remainder of the lease. Only the individual guarantor is released from his/her personal obligations by being a “Good Guy.” However, if the tenant is a shell entity specifically formed only to lease the space, the landlord may be left with an entity that has few assets to collect against in the event of a lease default.
These are just a few of the many issues a commercial retail landlord should consider when drafting a commercial lease.