Justinmcinerny - Seven Things You Need To Know …...SEVEN THINGS YOU NEED TO KNOW ABOUT COMMERCIAL LEASES 5 d. Personal guarantee – You probably operate your business as an LLC

By Justin McInerny, Esq.Attorney, business advisor, retail businessoperator, licensed real estate broker

YOU NEED TO KNOW ABOUTCOMMERCIAL LEASES

SEVEN THINGS

www.jmbusinesslaw.com

YOU NEED TO UNDERSTAND YOURLEASE, IT IS CRUCIAL TO THE SUCCESS,OR FAILURE, OF YOUR BUSINESS.


You’re reading this because you either have a business with a commercial lease or you are looking to buy a business with a commercial lease. So, let me guess, the landlord or broker handed you a lease that’s as thick as an old-fashioned phone book. You tried to read the thing but you practically fell asleep because it’s so stupidly long and boring. Even worse, you don’t understand half of it because lawyers have filled it with a bunch of technical speak that normal people can’t understand. This e-book will give you some quick tips to cut through the BS and get a basic understanding of commercial leases.

SEVEN THINGS YOU NEED TO KNOW ABOUT COMMERCIAL LEASES 1

THE LANDLORD IS NOT YOUR FRIEND


Your landlord is not your friend. Nor is your landlord your enemy. Your landlord is your creditor. But your landlord is not a normal creditor. Your landlord has the power to kick you out of your business and permanently close it. If you don’t watch what you’re doing, the landlord can legally change the lock to your business and there is nothing you can do about it. The landlord can even make you pay for the new lock. No other creditor, not even the IRS, can do that to your business. Although you don’t have to memorize and understand each and every word of the lease, you should know the lease’s main terms and be able to discuss them intelligently with your advisors, business partners and your landlord.

By that, I mean you should at least know:

1. The start/end datesa. When payment beginsb. When possession beginsc. When the lease ends – termination dated. Renewal Options

2. Rent/security deposita. Base rentb. Additional rentc. Deposit amountd. Who pays/personal guarantee

3. Tenant improvement money4. Who owns the equipment?5. What happens if I breach the lease?6. Lease assignment7. Termination of the lease


READ AND UNDERSTAND THE LEASE!!!


Bottom line is read the landlord’s proposed lease carefully, review it with your professional team (lawyer, accountant, broker). If you don’t understand something, then have someone on your team explain it to you. Then send the lease back to the landlord with your proposed changes. Be prepared to negotiate and to walk away if need be.

Lastly, understand that there are no ‘cookie cutter’ commercial leases. They vary greatly from landlord to landlord and deal to deal. The same landlord will not necessarily use the same lease for different tenants even if it’s for spaces in the same building. Some leases will include everything under the sun. Some leases will be shorter and might even leave out key provisions.



1. Start and end dates

a. The start date is typically called the ‘lease commencement date’. There are two types of lease commencement datesi. Payment commencement date – this is the day when

you actually start to pay the rent. Ideally you have negotiated a period of free rent. For example, you want to move in to the space on July 1 but you want to remodel the space until September 1 so you won’t be doing any business for two months. Ideally the landlord won’t charge rent during those two months when the business is not generating any money. This is also called a ‘rent abatement’ period.

ii. Possession commencement – Possession commencement date is when you actually move in to the space, whether or not you are paying rent. As mentioned above, hopefully you have negotiated some free rent i.e. a rent abatement period.

iii. Termination date – the last day of the lease. This is the day on which you must move out and leave the place ‘broom clean’ and/or in the condition it was in when you took possession of it. If you do not move out on that day then the lease usually says you are a ‘tenant in holdover’. Plus, commercial leases oftentimes state that the day after your lease terminates, you have a month to month lease and your rent automatically increases at least 150%.


2. Base rent/additional rent/annual rent increases/security deposits Most commercial leases provide for a flat monthly rent, plus additional rent due every month as well as a security deposit due before you take possession.

a. Base rent – Base rent is a set amount which you will be required to pay every month. It’s typically done in cost per square foot annually. For example, a 2,000 square foot space that rents for $32 per foot costs $64,000.00 per year. Here is how it’s calculated 2,000 square feet times $32 = $64,000.00. You then divide the $64,000.00 by 12 to get your monthly base rent. In this example $64,000.00 divided by 12 is $5,333.33, so that’s your monthly base rent.


b. Additional rent – most commercial leases require the tenant to pay additional rent on top of the base rent. The additional rent is often times called ‘triple net’ or NNN. Triple net means that the tenant pays base rent plus three additional things:1. real estate taxes, 2. building insurance, and3. maintenance.

These days, the meaning of triple net has become very broad and can include countless expenses such as the landlord’s office costs, security and advertising. Many leases, especially those in large buildings or shopping centers also include a ‘common area maintenance’ (CAM) charge in addition to base rent and triple net. CAM can cover anything the landlord pays for to maintain areas which are used by all of the tenants such as parking lots, sidewalks, stairwells and hallways. CAM fees pay for things like snow removal, janitorial services, and electricity in the common areas. Tenants payment of additional rent is based on the percentage of space the tenant occupies in a building. For example, if the tenant occupies 2,500 square feet of a 10,000 square foot building (25% of the building) then the tenant will pay additional rent of 25% to cover the landlord’s additional costs. So, if the landlord has real estate taxes, insurance, maintenance and/or CAM of $8,000.00 annually, the tenant will pay an extra $2,000 annually (25% of $8,000.00). This is usually added to each monthly rent payment. This means that on top of the monthly base rent, the tenant will pay another $166.66 monthly.

c. Rent increases – most commercial leases, at least in the DC metro area, provide that the base rent goes up 3% annually. These rent increases are usually called ‘escalation clauses’. Lately the escalation clauses have, in some leases, been reduced to around 2% annually because the cost of living has not been going up by 3% annually. Annual rent increases can also be based on the change in the Consumer Price Index (CPI) but I don’t see that too often. Additional rent increases, and sometimes decreases, depending on the Landlord’s annual expenses. Most leases state that the landlord will provide an annual statement of the landlord’s cost in taxes, insurance and maintenance.



d. Personal guarantee – You probably operate your business as an LLC or corporation. However, the landlord will almost certainly require you to personally guarantee the lease. In other words, if your business can not afford to pay the rent then you will be personally responsible for paying the rent.

e. Security Deposit – commercial leases usually require two month’s rent as security deposit, payable at the signing of the lease. Security deposits in commercial leases do not have to earn interest. They are refundable when you move out provided that your rent is all paid up and there is no damage to the space.


3. Tenant improvement money – Commercial landlords sometimes help tenants pay for a new buildout or renovation of the space. This ‘tenant improvement’ (TI) money is sometimes in the form of an allowance, or rent credit, sometimes the landlord will pay for it outright. It is all negotiable.

4. Who owns the what’s in the space?Many businesses require some expensive specialized equipment such as ovens and dishwashers for restaurants, car lifts in auto repair shops or heavy-duty safes for banks. The lease should clearly say who owns this equipment at the end of the lease.



5. Breach of lease – What happens I mess this thing up?Commercial leases almost always heavily favor the landlord even for big corporate tenants such as Starbucks or Best Buy. This means that if you breach (violate a term of) a commercial lease, the landlord can usually come down on you like a ton of bricks. Probably the most common breach is failing to pay the rent on time, but that’s just one way to breach a lease. Most leases provide for many other ways to be found in breach of a lease such as not being open enough days of the year, adding a partner without the landlord’s permission or not having enough insurance. Many leases don’t even allow you to fix or ‘cure’ the breach. Instead, the landlord can use the breach as a way to kick you out early if the landlord wants to take your space back. Keep in mind that in Maryland it can be perfectly legal for a landlord to lock you out of your business if you are in breach of the lease for any reason at all. Moral of the story, pay your rent on time, obey the terms of the lease closely and try to have a nice relationship with your landlord.

6. Assigning the lease/getting out early Let’s say you want to sell your business but you still have a few years left on the lease. There will be a provision in your lease which is usually called ‘assignment of the lease’. This will state how you can pass the lease along to a new tenant, or sub lease the space to a subtenant. Many landlords will allow you to assign the lease or sublease the space but you will usually have to seek permission in writing from the landlord and the new tenant or subtenant will have to go through an approval process. If you assign or sublease the space, expect the landlord to keep you on to guarantee the lease.



7. Termination of the lease - The lease will of course end on its termination date as stated in paragraph 1. But there are usually many other ways to terminate a lease, for example if you fail to pay rent and the landlord kicks you out either through locking the door or going through formal court eviction proceedings. The landlord might also have the right to terminate if the landlord wants to remodel the building or demolish the building and put up a new building. This should all be clearly written and negotiated in the lease.

YOU ARE A COMMERCIALLEASE GENIUS – NOT REALLY BUT . . .


Hopefully by now you have learned a lot about what actually goes on in a commercial lease. Before you dig into a commercial lease, get a large cup of coffee, a pen and paper then go to work. Take lots of notes, and take lots of breaks. Be prepared to read it in chunks, maybe over a few days’ time. Commercial leases are dense, complex documents which are commonly over 30 pages long. They are very hard to get through in one sitting. It’s vitally important that you understand your commercial lease. Seriously, your future depends on the lease. This means that you have to focus on learning about the lease. This e-book can’t cover every single aspect of commercial leasing but it’s a good place to start the learning process.


DON’T GO AT IT ALONE


Signing a commercial lease will have a major impact on your business, your income, your life and most importantly, your family’s life. If you sign a five-year lease with an average monthly payment of $5,000.00 that means you owe the landlord $300,000.00. That’s a lot of money. Would you like to talk with me to see how I can help you negotiate the best lease possible? If so, call me at 301 300-8947 or send an e-mail to me at [email protected].



ABOUT ME:

I am an attorney licensed in the State of Maryland with over twenty-five years as a trusted business and legal adviser. I help small business owners establish and grow their businesses.

While maintaining my law practice, I have also successfully operated a boutique beer and wine retail store in Maryland's DC suburbs since 2011. I have been a guest on WAMU’s Kojo Nmandi show and quoted in The Washington Post, Bethesda Magazine and WTOP radio. I am also a licensed real estate broker in the State of Maryland.

Justin F. McInernywww.jmbusinesslaw.com301 [email protected]


Documents

Justinmcinerny - Seven Things You Need To Know …...SEVEN THINGS YOU NEED TO KNOW ABOUT COMMERCIAL LEASES 5 d. Personal guarantee – You probably operate your business as an LLC