Knowing how to negotiate a lease agreement is a valuable skill that can save you thousands of dollars. One of the most essential elements of a business is its location. Location can make all the difference between success and failure. So don’t take it lightly. In this Quick Reference Guide, we’ll take a look at the main components of a lease agreement and examine each one in detail.
One task that every traditional business owner will have to face sooner or later is leasing some kind of space, whether for a warehouse, store, office, restaurant or something else. This factor is extremely important because, in effect, your business will be married to that location for at least a few years. In some cases, like that of a restaurant, the success or failure of the business is highly dependent on its location. In any case, it’s essential for a business owner to know at least the fundamental aspects of leasing a commercial property.
There’s really no such thing as cheap rent or expensive rent. It’s all a matter of paying the appropriate rent. Don’t make the mistake of choosing a space simply because the rent is cheap. It may end up costing you a lot in the long run. Remember that, when all is said and done, you’re not in business to save money on rent. You’re in business to sell your product or service.
Most of the time, if a particular space interests you, it’s because you can visualize your business there. It can be very tempting to sign the lease agreement right away. There’s always the fear that you may miss out on an incredible opportunity. It’s a completely natural reaction. Your entrepreneurial spirit is in high gear and you’re eager to get your business up and running as soon as possible. But as tempting as it may be, resist the urge to sign the lease agreement until you have reviewed it thoroughly, understand it completely and have verified and corroborated the main terms and conditions. If it’s really the right place for you, just let the negotiations flow naturally with no pressure. An error in negotiation could end up costing you dearly and cutting the future of your business short. Remember that you’re effectively entering into a marriage with the property. You wouldn’t take a marriage lightly, would you?
COST OF RENT
This is perhaps the most obvious question a new business owner will have. How much does it cost to rent a space? There are no preset prices for commercial leases. You’ll have to communicate directly with the landlord or leasing agent and ask about the cost to rent the space you’re interested in. In most cases, the price is established per share foot and will vary widely depending on the location. For example, the rent for a space in a large mall with a lot of foot traffic may be as high as $5 per square foot, while a warehouse in an industrial zone may only cost $0.40 per square foot. The higher the demand, the higher the price will be. You might say that the goal is to decrease the price per square foot as much as possible.
Basically, there’s a certain price for the property. That part’s easy enough to understand. It starts to get more complicated when it comes to negotiating the details of the lease, for example the final price per square foot, security deposits, rent in advance, additional costs, expirations, commissions, etc. Below, we’ll take a more detailed look at each of these points, plus a few others.
One of the first questions that will come up once you’ve chosen a space that seems suitable for your business has to do with time. How long of a lease should you get? Month to month? Two years? Ten years? It’s true that many new business owners prefer short-term lease agreements so they don’t feel like they’re taking on a long-term obligation. The problem is that any business takes time to establish itself, build a reputation and become successful. If the term of your agreement isn’t long enough, the landlord could require you to vacate the premises, just when your business is starting to take off. It’s sad, but it’s completely legal for the property owner to do this once your lease agreement expires.
What many business owners do is sign a lease agreement for a couple of years with an automatic renewal clause. This gives them the time they need to grow their business before they decide whether or not they want to remain in the same location.
Most lease agreements will give you the option of automatic renewals. You won’t be obligated to stay, but at the same time, you’ll have the assurance of knowing that, if your business is doing well, you’ll be able to stay if you want to. For example, you could lease a space for three years with two automatic renewals for two years, each. This way, you can try the place out for three years and, if everything’s going as planned, you’ll have four more years guaranteed.
This clause works in your favor because you’re the one who decides whether you want to stay or not. All you have to do is let the landlord know one way or the other.
TRIPLE NET LEASES & COMMON AREA MAINTENANCE ADDITIONAL EXPENSES
Most commercial properties entail additional expenses that aren’t indicated in the price per square foot. In a triple net lease (NNN), these expenses are basically related to common area maintenance (CAM). It’s very important for you to know and clearly understand the additional expenses you’re expected to pay so you avoid any potential surprises or headaches down the road. For example, how would you feel if you were expecting to pay $2,000 per month in rent and then received a bill for $2,900? That’s why it’s vital for you to find out how much these additional expenses are before you sign the lease agreement.
Additional expenses are related to the common areas shared by all of the tenants and are generally distributed proportionately among them. For example, if you rent a space in a shopping center with 20 units, all of the units will chip in their share of the additional expenses. What exactly are these additional expenses that aren’t included in the rent? They may cover the costs of water, electricity, alarms and security systems, a security guard, parking lot landscaping, general maintenance, the bathrooms, signage, shopping center promotions, insurance and property taxes, among other things. Even though you are only leasing a space, your customers use the bathrooms and parking facilities, which must be well-maintained, and they benefit from things like security guards and insurance, which are there for their protection.
CONCESSIONS (FREE RENT)
Many new business owners confuse commercial properties and residential properties. In a residential lease, when renting an apartment or condominium, for example, you usually start paying rent from the day you take possession of the premises. However, in a commercial lease, this isn’t necessarily the case. It’s very common to negotiate anywhere from a month to six months rent-free. This is because it can take up to six months to build out the space before you can start operating your business. You’ll need to do some remodeling and make some improvements, and these will require permits. Therefore, you should ask that the agreement include a concession of at least a couple of months rent-free so you can take the time you need to get the space ready without having to pay rent as of the very first day. In many cases, the landlord or leasing agent will say yes if you ask.
Once you sign the lease agreement, you’ll generally be required to pay a security deposit. This is almost universal. Landlords ask for these deposits in case you fail to fulfill your obligation to leave the space in the same condition it was in when you got it. Anything from a simple change in the color of the walls to new flooring or décor can end up costing the landlord a lot of money. A security deposit will range from one to three months’ rent. Naturally, it’s desirable to negotiate the smallest deposit possible so you don’t tie up too much of your working capital. When you first open a business, it’s much better to invest your money in your operations than in deposits that you’ll probably never get back.
A commercial space for rent is usually presented in what is known as “shell condition.” In other words, when you take possession of the premises, all they’ll have are white walls, carpeting or cement floors, electricity, drinking water and a bathroom. In most cases, this isn’t the ideal setting in which you’ll want to open your new business. For example, if you’re going to open a restaurant, you’ll probably want to paint the walls to create just the right atmosphere. You might want to install tile floors, a fountain, picture windows, pillars or some other decorative element. These improvements will cost you a lot of money and you won’t be able to take them with you when you leave. In effect, you’re improving the property to the landlord’s benefit. For this very reason, you can negotiate with the landlord to give you an allowance for these improvements.
Let’s say you’re going to invest $50,000 in leasehold improvements. You could ask the landlord for an allowance of 20 percent ($10,000). While it’s very unlikely that you’ll get cash, you may get a corresponding reduction in your rent or several months rent-free. You have nothing to lose by negotiating this very beneficial clause.
A broker or commercial leasing agent can be a valuable resource. You can contact an agent to represent you in negotiating a lease agreement or to help you find a commercial property that meets your specifications. The best part is that these agents are generally compensated through a commission that’s paid by the property owner. In other words, you get the services of a professional who negotiates on your behalf without costing you a penny. However, even if you have a broker, you must still review and verify the clauses of the lease agreement. At the end of the day, it’s your money, your business and your future. Don’t put it in someone else’s hands without at least checking everything for yourself.
"IN LIFE, YOU DON’T NECESSARILY
GET WHAT YOU DESERVE BUT, RATHER,
WHAT YOU’VE NEGOTIATED"