Signing a commercial lease is a major step for your business. Hopefully, it turns out to be an exciting new opportunity that propels your organization to new levels of success. If the process goes well, you’ll have space that better matches your brand, accommodates your growth, saves you capital, and more. However, if you sign a bad lease, you could end up paying too much, find yourself in a bad space, or both for years to come.
The mistakes that lead to bad commercial real estate decisions are easy to avoid, though. If you follow these steps, you can protect your business and position yourself to sign a great commercial lease.
Do Your Homework
Before you even start thinking about a specific building or a specific space, step back and do your homework.
- What you need
- What you are willing to spend
- Where you want to be
- Where you see your business going (over the entire term of the lease that you’ll be signing — at a minimum)
To do this, you need to study what you’re already doing in your existing offices or other commercial spaces. Then, get all of the stakeholders together to understand their present and future needs. Once you’ve done that homework, you’re ready to move on to the next part of the process.
Once you have a sense of what you need, go out and find a good tenant rep to help you. Tenant representatives are specialized commercial real estate brokers that are experts in representing people that use space — like your company. They know which questions to ask, know the market, and understand how to drive value for you as a tenant, as opposed to most brokers who are primarily focused on driving value for the landlord. Great tenant reps save you money, protect you from signing bad leases, and usually don’t charge you a penny for all of the value that they bring!
Go Through the Details in Your Lease
It’s pretty standard advice to say that you should read your commercial lease — or any legal agreement — before you sign it, but it’s also standard advice that gets ignored on a regular basis. After all, you probably don’t read the entire jacket when you rent a car on a business trip. Skipping the details of some documents might be an acceptable risk, but it isn’t when it comes to your lease. Leases are complicated legal documents and single words can radically impact their economics. For this reason, it’s a good idea to read your lease carefully, have your tenant rep review it, and have a real estate attorney take a look at it as well.
Get in Touch With the Neighbors
If you want to find out what it’s really like to be a tenant in a given building, talking to other business is an excellent way to cut through the marketing script and get a real world sense of what it would be like to occupy a given space. Your tenant representative can guide you as to what the local customs are about talking with other tenants, how to do it without antagonizing the landlord, and which questions are appropriate to ask. In addition, the landlord might also provide tenants to whom you can reach out.
It’s unlikely that your co-tenants will tell you about the details of the commercial leases they signed their spaces. That information is usually confidential. But it’s completely reasonable to talk to them about how the building is managed, how quickly the elevators run, whether it stays warm in winter and cool in summer, and similar questions. Those day to day concerns can have a big impact on your employees’ satisfaction and productivity, so learning about them before you sign a lease can protect you from making a mistake.
Think About the Future
A commercial lease is a long-term commitment. Offices generally get leased for five to ten year terms and given the cost of moving and reconfiguring a new space, you might not want to leave after your lease renews. This means that you could conceivably be in the same place for decades.
Usually, thinking about the future means choosing a space where you either have enough room within your demising walls or choosing one that has expansion options that will let you take over adjacent spaces or floors. Given the rate at which businesses are changing, though, you may also want to plan for a shrinking office — or one which you split up into multiple small offices across the city. In that case, you will want to look for a space that can be easily demised into smaller suites. Factors like the location of HVAC control units and egress points can impact how easily you can split up a space for the future. Your tenant rep can recommend a good space planner to help you devise a good plan.
The future also brings other changes. Are you sure that the emerging suburban location that you like will still be popular in seven years? On the other hand, will your employees still be willing to commute downtown if they all move out to the suburbs? And does the building have enough wiring for devices, bandwidth for networking, and 5G service for future cell phones?
Assess All Costs
Signing a commercial lease exposes you to a whole range of difference costs. Your rent and any proposed increases over the life of your lease are likely significant, but they are far from the only expenses that you will be paying. Pay careful attention to the building’s operating expenses and to how you will be held responsible for them. If you can, get a history to get a sense of ow the building is managed. If repair and maintenance costs are low, for instance, it could be a sign of higher cost in the future as deferred maintenance causes higher than normal repair bills.
Realize that if you aren’t being billed for something, you probably need to pay for it yourself. An example of this is if you are looking at an office building in flex space, which is a common practice in some western secondary markets. In your office building, janitorial service and electric service is usually included in your rent. In a flex building, your electricity is usually separately metered and billed to you, and the landlord might not make any provisions for janitorial service. If you want your office cleaned, your choices are to contract for a third party provider or buy a vacuum cleaner. It’s important to carefully assess which expenses are in your rent, which are in your pass-throughs, and which are completely up to you.
The cost of occupying a commercial space goes well beyond rent and operating expenses, though. Pay careful attention to any hidden costs at the building. After hours charges for access to lighting, HVAC and elevators can add up quickly if your employees burn the proverbial midnight oil. Parking costs can also add up, especially if you have a densely packed office in a downtown building with limited parking.
Building and furnishing your space can add up quickly as well. Even if you have the same tenant improvement allowance at two different buildings, that allowance could mean different things in different buildings. If one has reusable elements in place, building could be less expensive. On the other hand, if a building requires you to use certain types of high cost materials or to work with a specified construction firm, you could end up spending much more than in a property where you have more control. The configuration and layout of the space can also impact how much furniture you need, what type, and how you place it.
Finally, once you’ve leased the space, built it and furnished it, there are still additional costs that you need to consider. Ongoing services like coffee for the break room, paper for the copy room and Internet connectivity add cost. The city you choose can also add cost to your space. Are you located in a jurisdiction with local income or payroll tax? Are you in a city with a higher minimum wage or with insurance or leave provisions that affect your benefit costs? That might be a reason to look at a suburban space (or, on the other hand, to avoid a suburban space).
We understand that there is a great deal to assess here. And that’s where getting expert help from the stakeholders in your company and from outside practitioners like real estate attorneys and a tenant rep can help you make a better decision and avoid a bad commercial lease.
Don’t Make Office Decision Solely on Price
Although we just spent paragraphs talking about cost concerns, remember that the office you occupy isn’t just a line item on your company’s profit and loss statement. Your office is your business’s home. It’s where recruits choose to join you, where your employees spend their time, and where your customers get to know you better. The idea isn’t to spend the least amount of money possible — unless extreme frugality is your culture. Instead, it’s to get the highest possible return on investment on your real estate dollars by getting the right space at the right place. Just going for the cheapest space is a sure fire way to end up with a bad lease and a big problem down the line.
Pay Close Attention to the End of the Lease
The ending of your commercial lease can be as important as the beginning. When your lease expires, one of two things will happen. You will either want to leave the space or stay in it, and it’s easier to prepare for both possible outcomes in the beginning than it is to catch up once your expiration date is right around the corner.
They key to being able to stay in your space is to have renewal options written into your initial commercial lease. These options let you stay in the space for an additional term — frequently five years per option — on a predetermined basis. For instance, your option might let you renew at a 5 percent increase from you last year’s lease rate, or renew at 95 percent of the current fair market value for your space.
The magic of the option is that it gives you control. If the option is a good deal, you can take it and your landlord can’t throw you out of your space even if they have another prospect that is willing to pay more for it. If the option is a bad deal in the market of the future, though, it’s likely that your landlord would be desperate to hold on to you and that they would be willing to negotiate. It won’t cost you anything to ask for a better deal in that instance.
When you sign the lease look at what happens if you want to leave. See what kind of notification you need to give your landlord, and pay careful attention to what you have to do when you vacate the space. Do you have to clean it? Remove your furniture? Or return the space back to the condition in which you took it (which could involve demolition work)? Furthermore, if you need to stay past the expiration date, is that allowed? If so, what will it cost you in terms of holdover rent? Answering these questions about your commercial lease now can save you from expensive surprises later.
Checklist of Questions to Ask Before Signing a Commercial Lease
We have given you a large pool of great ways to avoid signing a lease, but here are ten questions that will give you a good sense of what you are getting into.
- How old is the building? You don’t need to automatically worry about an old building, but be aware that the older the building, the more likely it is to have higher energy costs and higher repair and maintenance costs unless the owners have updated it.
- Can I build out my space? Make sure that the landlord will let you configure your space to your specific needs. If they will offer a tenant improvement allowance to help defray some of the cost, that’s even better.
- Does my rent go up? How much? Rent escalations are common in commercial leases. It’s important to understand how much your rent will increase and how those increases get calculated. Fixed increases of x dollars or cents per square foot per year and increases tied to the Consumer Price Index are both common.
- How much are the common area maintenance (CAM) charges? Get a sense of what building costs will be passed through to you, since CAMs and related costs can add up very quickly.
- Do you allow signage? If your company wants a sign on the building, ask about signage rights — and costs — up front.
- Do you offer parking? When your workers drive to the office, the ratio of spaces to space in the building (called the parking ratio) will give you a sense of how many parking spaces are available. Make sure that the building has enough space for your workers and has reasonable parking costs.
- Who are my co-tenants? Gain an understanding of who else is in the building with you. Look for compatible co-tenants that will enhance your business, instead of detracting from it.
- Is my lease assignable? Do you allow subleases? The right to assign or sublet your space gives you flexibility in case you need to leave before your lease expires.
- How do lease renewals work? As we discussed above, it’s easier to discuss the renewal process before you and your landlord are under the gun of a deadline.
- What are the building’s amenities? Amenities can impress customers, excite prospects, and keep employees happy. the right ones can also save you a great deal of money. Get an understanding of the building’s amenity package and work with your tenant rep to value them.
Signing a commercial lease is an undertaking, and avoiding a bad one is a major undertaking. It’s doubly hard if you aren’t a full-time commercial real estate practitioner. As dedicated tenant reps, we can help you avoid a bad lease. Reach out to learn more about our services.