Aligning Your Site Selection Process to Avoid Delays in Commencement
A tenant searching for industrial space today may need to wait for months in order to gain possession of a newly leased location. Tenants can often blame the "vacancy domino", where a lack of vacancy in one space is preventing vacancy in others, for such delays. While U.S. industrial vacancies were at 5.3% in the 3Q 2020 according to Cushman & Wakefield, in many major industrial markets the vacancy is lower than 3% with many size segments hovering near zero. With such a lack of available and vacant space to choose from, companies should pay particular attention to how they are negotiating possession and lease commencement in new lease agreements and how they are communicating with their current landlord if there is a possibility of holdover.
Possession and Lease Commencement in the Letter of Intent
Identifying when the tenant will possess a space and when the lease will commence should be clearly addressed in the letter of intent, a non-binding document which outlines the business terms acceptable to the tenant and landlord. Key considerations in how the tenant negotiates possession and lease commencement with a landlord in a letter of intent are as follows:
When the company needs access to the space and when it needs to be operational. Early occupancy typically allows the tenant to access a space for the setup of any furniture, fixtures, and equipment (FF&E). However, lease commencement typically will be tied to when you plan on being operational and in full possession of the premises.
Is the new space vacant and unencumbered? Even if the space is vacant, it can still be on a lease which may delay possession and lease commencement unless otherwise terminated. Obviously the landlord cannot legally lease the same premises to two entities, but a lease termination could delay any planned improvements.
Is there make-ready, landlord, or tenant improvements required? Landlords typically want the lease to commence by a fixed date. Unless the tenant is certain any make-ready or landlord work that needs to be completed before they can be operational will be completed by a certain date, at a minimum it should pursue a lease commencement date that is subject to the substantial completion of the make-ready and landlord work. If any tenant improvements are necessary to correct a building deficiency required for the tenant to operate, it is reasonable to also subject the lease commencement date to their substantial completion.
Possession and Lease Commencement in the Lease
Once the tenant and landlord have agreed to business terms, the focus for the tenant should be meeting its timing objectives within the lease agreement. In regards to delay in commencement or possession, it is usually impractical or undesirable to address all of the considerations in the event of a delay in a letter of intent. Therefore, the delay in commencement or delay in possession provisions within the lease agreement will usually contain several additional business terms which would need to be negotiated by the parties.
In general, such provisions answer the question of what happens in the event of a delay in commencement or possession. In order to answer that question, most delay provisions focus on the following key elements:
Tenant's liability for rent payments if possession is delayed. If the landlord does not turn over possession to the tenant but the lease commences, does the tenant need to pay rent or is their rent abated until possession is given. While it may seem like few tenants would agree to pay rent on a space before they are given possession, many landlord favorable leases will stipulate a date certain by which the lease will commence regardless of whether the tenant is in possession of the premises.
Landlord's liability for a delay. If the landlord is unable to deliver possession or commence the lease by a certain date, what liability, if any, do they have. For example, if the landlord is unable to grant possession to the tenant by a certain date and incurs holdover, should the landlord be liable for their holdover costs.
Impact to the rent abatement, tenant improvement allowance expiration, and lease expiration date. If there is a delay in commencement, does it diminish the amount of rent abatement the tenant has negotiated, does the date by which the tenant needs to spend the tenant improvement allowance get extended, and does the lease expiration get extended as well? Tenants should make sure there is no reduction in the amount of rent abatement and the date by which they need to spend a tenant improvement allowance is extended due to any delay outside of their control.
Tenant's liability for delay. Even though they are not in possession of the property, tenants can cause delays in possession or lease commencement. Most commonly, if a tenant improvement work letter required certain actions by a tenant in order to proceed with improvements, the tenant could end up causing a delay in the lease commencement if those actions are delayed. Interfering with the landlord's ability to complete make ready work while enjoying early occupancy is another example of potential tenant liability for delays. Tenant's should try to minimize their liability for delays to the extent reasonable in the lease and not allow the landlord to associate unrelated requirements of the tenant with a delay in lease commencement.
When can the tenant terminate the lease due to a delay? If a delay in possession or lease commencement continues long enough, tenants will typically want the ability to terminate the lease. Even though a tenant may enjoy abated rent while possession is delayed, they still need to operate their business. Typical termination rights due to delay in commencement or possession range from 60-90 days following the scheduled commencement date. However, tenants may need to give notice within a short period of time in order to terminate. Tenants should therefore be thoughtful about how long they might be willing to stick around and make sure to stipulate that any monies given to the landlord would be returned in a reasonable period of time should they terminate the lease due to a delay.
How does Force Majeure impact delays in lease commencement or possession? Many leases specifically delineate what happens in delays due to Force Majeure events and for other reasons. The logic being since Force Majeure is outside the landlord's control, they should be treated differently. However, many causes for delays are outside of the landlord's control including the most common, holdover.
Early possession should be a negotiated benefit, not just a "give away" to the tenant by the landlord. Tenants should ideally obtain early possession as soon as the premises is vacant, the lease has been fully executed, and all monies and documents due upon execution have been delivered. Tenants should be particularly aware of associating the start of early possession to the substantial completion of landlord make ready work, especially when substantial completion of landlord make ready work is when the lease commences.
Use commencement date agreements, ideally as an exhibit to the lease agreement. Commencement date agreements typically identify the actual date the lease commences and expires, that both parties have fulfilled any obligations required for the lease to commence, and that there are no other conditions required for the lease to have commenced. It should protect both parties in the event either or a future interested party disputes the lease commencement date.
Communicate with the Current Landlord Regarding Holdover
If your company is relocating to a new space that will be subject to a delay, don't wait for your company's current lease to expire to start a conversation with your landlord. Many landlords will understand delays outside of a tenants control, and often times will not charge a premium to holdover as long as they are given sufficient notice and the ability to consent to a definitive holdover period.
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