The current market favors tenants and, even in a tight market, smart landlords realize that the old philosophy of the landLORD and the tenANT doesn’t apply. Tenants shouldn’t count on the market or a landlord’s good will to protect their interests. The following tips are designed to level the playing field, create an atmosphere of mutual respect and preserve the benefit of the tenant’s bargain.
• Title, zoning and hazardous materials. If there is a large tenant investment involved – where the tenant is paying a lot for improvements and where the location is crucial for its business – tenant’s counsel should review a copy of the landlord’s title policy, site plan and hazardous waste reports to verify what the correct, legal landlord entity is; if there are any historic or other restrictions; or if there are any easements or deed restrictions that may affect the tenant’s use or ability to make alterations. If parking is crucial to the business’ success, it’s necessary to compare the site plan with the title policy to determine if the parking lot is a part of the building’s property that is actually owned by your landlord.
It’s necessary to confirm that the tenant’s main and accessory uses are permitted by the zoning code or if a special permit is needed for one or all of the desired uses. Tenants also should review hazardous material reports because there may be asbestos in the flooring, ceiling or piping, or PCBs in the florescent lights that will cause the tenant time and money to remove before improvements can begin.
• Non-disturbance agreements. A non-disturbance agreement is a direct contract between the tenant and the landlord’s lender that stipulates that the tenant may remain in its space on all the terms of the lease despite a landlord mortgage default and lender foreclosure. The agreement protects the tenant if the bank figures the property they now own will be worth more with the tenant gone and a larger or higher-paying tenant replacing the original one.
• Utilities. Another due diligence check for tenants who are large electricity users is to check with the utility company about its capacity to handle the tenant’s needs. It would be problematic to find out in the middle of the tenant’s construction that the transformer under the street doesn’t have enough capacity to handle higher usage. If a tenant has above-average water usage, it should check to see if the city or town has a water moratorium on new hookups. On the other hand, if a tenant has customary utility needs in a building that isn’t fully separately metered for each tenant, then it should make sure that other tenants in the building, such as restaurants, aren’t using more utilities than normal, as the common utility bills will be above normal.
• Tenant build-outs. Landlords don’t give tenants anything for free. While there may be a generous build-out allowance, it really is the tenant’s money because it’s part of the whole rent package. If the tenant does the build-out, it will be taking the risk of delays in getting the use, building and signage permits. Tenants should protect themselves by extending the rent commencement date and getting a real rent credit that would start after that date if there are landlord delays in preparing space for the tenant. Delays may occur if a hazardous material like asbestos is found in the space, or if the tenant can’t pull a building permit or Certificate of Occupancy if there are code violations elsewhere in building. One alternative is to negotiate that the landlord take responsibility for the build-out as part of the lease. The landlord is likely to choose a general contractor that knows the building and the system idiosyncrasies. The construction could be more efficient with fewer surprises behind the walls and may even be cheaper than with a general contractor who must become familiar with the building during the construction process. Rent also could be tied to delivery of the improved space so the landlord has an incentive to deliver on time. Of course, where the construction allowance is less than the build-out cost and the tenant is expected to pay the difference there should be safeguards (for example, a review of the amount of the contractor’s overhead and profit charges, no extra landlord supervision costs, no overtime or premium labor changes or freight elevator fees).
• Plan for the possibility that a landlord will disturb the tenant’s business operations. Landlords periodically undertake significant building improvements and relocation programs. Plan for the possibility that the landlord may cover the tenant’s business signage with scaffolding or close off points of access to the business. The tenant should get a rental abatement if there will be more than a temporary interference with the business signage, visibility, storefront or parking.
• Plan for success, don’t be a victim of it. Ask for an option to extend the lease term at 90 percent to 95 percent of market rent (to reflect no brokerage fees and no vacancy rent loss). Seek the option to expand into contiguous space. Don’t agree to a forced relocation to new space.
• Operating expenses and real estate taxes. Make sure that the base years are realistic and not artificially low. For example, in a new building where there is no real operating experience, the base number might be just an educated guess, and there might be a low tax assessment because the building wasn’t fully leased up when the base year assessment was set. Tenants shouldn’t be responsible for any “linkage” tax payments the landlord may be obligated to pay; those should be part of the landlord’s cost of developing the building. Also, make sure the variable operating expenses for the base year are “grossed up” to reflect the higher of actual occupancy or a 95 percent occupancy.
There are very long lists of operating cost exclusions that should be inserted into the lease, including the usual list of landlord’s debt service costs, brokerage and marketing costs, depreciation and lease enforcement costs, hazardous materials cleanup as well as artwork and health club dues for building management employees. Capital costs and improvements are potential big-ticket items of which to be cognizant as well. The tenant needs to limit the cost of the improvement to the amount of actual yearly savings realized instead of just the amortized GAAP useful life if it’s larger than the actual cost savings.
• Enforcement. A good attorney can negotiate a lot of lease protections for the tenant, but unless the tenant takes the time to make sure the landlord is honoring its highly negotiated agreements, the tenant is wasting its money. The tenant must enforce its favorable lease terms the first year, even if it’s not paying any additional rent for operating expenses or taxes that year. Check each landlord invoice scrupulously against the specific negotiated lease terms to avoid overcharges. The tenant should set the tone of respect as well as ensure a reporting system that will be used during the rest of the lease term.
