10 Suggestions for Negotiating Your Next Industrial Lease to Save Your Company Time and Money
Key Concepts
Industrial leases often contain many more business points than a typical letter of intent or proposal, the non-binding documents used to negotiate business terms before incorporating them into a lease.
For those involved with real estate for their company, this article identifies 10 key business points in industrial leases that are usually not covered in a letter of intent or proposal. If properly negotiated, these 10 suggestions can save your company a significant amount of time and money during the lease term.
The 10 suggestions are 1) Create Flexible Use Provisions; 2) Allow Automatic Electronic Rent and Operating Expense Payments; 3) Pay for the Landlord to Assume Maintenance Obligations; 4) Transform a Tenant Improvement Allowance into Landlord’s Work; 5) Structure Stay / Go Alterations; 6) Keep Profit Sharing in Subleases and Ensure Assignment or Subletting Cannot be Unreasonably Withheld; 7) Require the Landlord to Provide Notice should their Contact Information Change; 8) Make Sure the Events of Default are Reasonable; 9) Negotiate a Limited Hold-Over Grace Period; and 10) Incorporate Move-In and Move-Out Exhibits
#1-Create Flexible Use Provisions
The use provision of a lease is a description of the planned operation for a leased property. Their purpose is generally to legally limit the type of operations the tenant can conduct during the lease term. For example, a landlord may not want a tenant to use their property for a dangerous or unlawful purpose.
However, a company may want to change its use during the term of the lease in ways that are not dangerous or unlawful. Sometimes these changes in their use will no longer align with the use description in the lease.
Rather than taking the risk of default or approaching the landlord for an amendment to address the change in use, it is much more efficient to create flexibility in the use provision when negotiating the lease.
Here are three suggestions for improving the use provision in the draft lease:
Broaden the use description to include all legally permissible uses, perhaps subject to reasonable restrictions for hazardous materials or uses not permitted by code.
Allow for changes to the use description to be automatically permitted, again subject to reasonable restrictions.
If the Landlord won’t accept 1 or 2, try having use changes be permissible with their consent, which shall not be unreasonably withheld.
#2-Allow Automatic Electronic Rent and Operating Expense Payments
Make sure your lease allows for electronic payments. Paying by check by mail is significantly increasing the chance of a late rent payment, especially if the check is not sent automatically.
Automated Clearing House (“ACH”) or Electronic Fund Transfer (“EFT”) should always be permitted under a lease as an acceptable method of payment. It’s 2021. There really is no excuse for a landlord or tenant not agreeing to electronic payments of rent and operating expenses.
#3-Pay for the Landlord to Assume Maintenance Obligations
Letter of intents or proposals usually have a provision detailing whether the tenant or landlord is responsible for the maintenance of certain elements within the premises.
If your company has agreed to be responsible for the maintenance of certain items such as the HVAC, roof, plumbing, and electrical in a letter of intent, consider negotiating a lease where the landlord or their manager assumes those responsibilities but passes through the maintenance costs as an operating expense.
Companies often do not have the expertise or business interest in maintaining certain components in a property. Paying a landlord or their manager to maintain those elements is often an easier route for companies than managing vendors and maintenance contracts.
#4-Transform a Tenant Improvement Allowance into Landlord’s Work
Tenant improvement allowances are often used in letter of intents or proposals because they are:
familiar to landlords and tenants
usually relatable to a “market” tenant improvement allowance per square foot
easier to negotiate than a punch-list of improvements
Tenants would typically be reimbursed by the landlord for any approved tenant improvements out of the tenant improvement allowance. Once the allowance has been spent, the tenant is responsible for any additional costs.
However, it often makes more sense for the landlord or their manager to manage a tenant improvement project than a tenant. As with maintenance, tenants often lack the level of relationships with contractors and other vendors that landlords have.
I often will incorporate a tenant improvement allowance and a punch-list of work done by the landlord out of the allowance in a letter of intent. However, this is not always possible-especially if the tenant does not have a full understanding of what tenant improvements they need.
If your company negotiated a tenant improvement allowance in a letter of intent or proposal, consider trying to negotiate using the tenant improvement dollars towards a punch-list of work the landlord will perform on your company’s behalf in the lease.
#5-Structure Stay / Go Alterations
Alterations are usually defined as tenant improvements made during the term of the lease which require landlord’s approval. Whether improvements are alterations usually relates to a minimum cost of improvements or if the improvements will affect certain areas of the premises, such as the roof.
Alternation provisions in a lease typically contain the following elements:
What defines an alteration
Is consent required and how is it granted
What happens to the alteration at the end of the lease
Most leases allow alterations with consent, but require the tenant to remove an alteration at the end of the lease if notified by the landlord. This can lead to an unplanned cost to remove an alteration at the end of the lease, and could result in holdover in order to remove it and restore the premises to its original condition.
One way to address this issue is to negotiate lease language requiring the landlord to determine if they will allow the alteration to stay or be removed at the end of the lease term as part of their consent. This will allow your company to budget and plan for the removal of any alternations without waiting for the landlord make a determination at the end of the lease term.
#6-Keep Profit Sharing in Subleases and Ensure Assignment or Subletting Cannot be Unreasonably Withheld
Some landlords dislike the idea of a tenant profiting from the sublease of their property. However, taking 100% of the sublease profit from a tenant has some unintended consequences.
In a market where rents have appreciated substantially there is no incentive for a tenant to charge more for a sublease than what they are currently paying. This means no profit for the landlord or tenant.
I would suggest making sure the lease states your company keeps at least 50% of any sublease profit, ideally after any expenses relating to the sublease.
Also, if landlord consent is required for assignment or subletting, make sure their consent cannot be unreasonably withheld. Leaving consent to assign or sublet in the landlord’s sole discretion can lead to a lot of frustration and rent paid on unused space.
#7-Require the Landlord to Provide Notice should their Contact Information Change
When you have to get the landlord to address an issue, it is really frustrating when you can’t reach them. Unfortunately most leases lack requirements for the landlord to update their contact information when it changes. They often also limit such contact information to the notice provision containing an address, attention of a certain title.
A simple solution is to add the following points to the lease:
Requiring both parties to notify the other if their primary contact information changes.
Create a dedicated, non-personal email address for the purpose of receiving informal notices and possibly formal notices with legal approval.
Add phone numbers, even if they are main lines.
It is also a good idea to address the inability to contact a landlord in other areas of the lease, such as performing any required repairs or consenting to a sublease.
#8-Make Sure the Events of Default are Reasonable
A default of a lease is a failure to comply with a provision of a lease agreement. Often these relate to the tenant performing certain actions by a certain period of time, such as payment of rent. Default usually have penalties associated with them and can lead to the inability of a tenant to exercise options or sublease their space unless they are cured or rectified.
However, accidents happen. An ACH payment gets inadvertently deleted. A virus infects the company’s network, causing a delay in an estoppel. A notice was lost in the mail. These events are not intentional and, if infrequent, should not cause the tenant to have substantial financial penalties or credit risk under a lease.
Events of default provisions should be reasonable and not overly punitive towards infrequent events. The following are some suggestions to consider when negotiating events of default in your next lease:
Define a default based on a period of time following landlord’s written notice of late rent, not the days past when the rent was due.
Allow for a reasonable number of business days from landlord’s written notice before a tenant will go into default. Reasonable will vary by requirement. For instance, a shorter number of days is reasonable for rent and proof of insurance while a longer number of days is reasonable for other matters.
#9-Negotiate a Limited Hold-Over Grace Period
Hold-over is the period of time a tenant continues to occupy a space after the lease has expired.
Most hold-over lease provisions contain an increased base rent that is charged during the hold-over period, ranging from 120% to over 200% over the base rent in the last month of the lease term.
Unfortunately there are events outside of the control of a tenant that can lead to hold-over. For example, moving to another space requires it to be vacant and any improvements substantially complete in order to occupy.
In order to avoid hold-over rent if your company needs a little more time to vacate a space, you might consider negotiating the following in your next lease:
Up to 30 days to vacate at the rent equal to the last month of the lease term, prorated by 1/30 for every date your company remain in the space.
An option to remain in the space for up to 60 days if landlord is provided notice no later than three months prior to the lease expiring.
A graduated scale of hold-over rent, flat from the last month’s rent for a period of time, then the daily rate increases until reaching a maximum amount.
A limited period of time to hold-over at the last month’s rent until the landlord can provide evidence that they need the space back to re-tenant (i.e. have a LOI and require 3 months to refurbish before the lease commencement)
The landlord will likely object to any grace period but unless their property is in a low vacancy market, a limited grace period has a low risk of adversely affecting their ability to re-lease the property, which is usually their biggest concern. to make the above ideas more reasonable, you may add an escalator to the last month’s rent equal to a fixed rent increase during the lease term.
#10-Incorporate Move-In and Move-Out Exhibits
Move-in and move-out exhibits detail the condition of the space when a company takes occupancy and the expected condition when they vacate.
Documenting the condition of a space at the beginning of the lease can serve as a baseline for the expected condition at the expiration of a lease. Normally this means the space will be in the same condition when the tenant took possession, less normal wear and tear.
A move-in exhibit can include:
Documenting any noticeable damage within the premises such as cracks in the floor, dents in loading doors, or surface issues in the parking lot / loading area
A property condition assessment (PCA) done by a professional inspection company
Baseline phase one environmental assessment
Conversely, a move-out exhibit generally details the condition of the premises the tenant agrees to surrender to the landlord at the end of the lease term. These exhibits generally include:
Requirements for all personal property, trade fixtures, and alternations not permitted to remain to be removed
Procedures for joint inspections and turn-over of the premises
Expected condition of certain components within the premises at the expiration of the lease
These exhibits can make the move-out process much easier and less contentious with a landlord.
Next Steps
Thanks for reading this post on 10 suggestions for improving your company’s next industrial lease. This post is not meant to be legal advice and please hire a real estate attorney to review and make any changes to an industrial lease before signing it!
If you want to learn more about ways to improve how your company handles real estate requirements, check out my Tactics posts by clicking here or hit Talk to Chuck below to reach me directly.
