A practical guide to help industrial tenants think about the best way to maintain leased property
Every company wants to avoid property maintenance issues during their occupancy of a property. While there is a common focus on the immediate economic results of leasing a property, most industrial tenants should pay closer attention to how they have negotiated property maintenance obligations. I would wager very few of them would trade allowing disruptions to their operations or surprise replacement costs in exchange for an extra penny or two per square foot in landlord concessions. Such a wager is based in the realization that the maintenance of a leased property can significantly impact an industrial operation and its financials during a lease term in ways few other lease provisions can. It is a high-risk area.
Improperly maintained properties can lead to interruptions in an industrial operation, causing widespread ramifications through a company’s supply chain. Many industrial operations have been adversely impacted by significant roof leaks, electrical interruptions, flooding, and sprinkler system failures. Operational efficiencies and key performance indicators can be reduced due to broken dock equipment, lighting ballast failure, and yard surfaces in disrepair. Employees can suffer when air conditioning, plumbing, or lighting malfunctions. Even when repairs take place, uninsured costs due to disruption, property damage, and loss of morale can far exceed the costs to repair the damaged property components.
In addition to disruptions, the industrial tenant can be exposed to the unplanned maintenance charge, a potential existential risk to their profit and loss statement for a particular operation. Some industrial property components can cost millions of dollars to repair or replace. If the industrial company is legally responsible for the cost of the repair or replacement of such a component, it will undoubtedly adversely impact its financials. A third party logistics company, for example, can wipe out the profitability of their entire customer contract with a large maintenance repair or replacement bill.
Lastly, industrial companies are not in the business of maintaining industrial property. Most companies want to dedicate all of their available resources towards achieving their business objectives. This can lead to a misalignment between the responsibilities an industrial company accepts under a lease and what they actually should perform in their best interest.
In this post I discuss what industrial property maintenance means to the industrial tenant, how industrial tenants can think about and address how an industrial property is maintained, and finally a summary of maintenance best practices to help reduce the risk of negative outcomes during the lease term.
Defining Property Maintenance
The maintenance of an industrial property under a lease consists of the answers to four questions:
- What is the type of maintenance being considered?
- Where is the maintenance being considered performed?
- Who is performing and paying for the maintenance being considered?
- How should they perform the maintenance being considered?
The type of maintenance refers to at least three categories common to the vast majority of industrial leases:
- general cleaning and upkeep;
- and replacements.
General cleaning and upkeep includes keeping an area clean and free of debris, performing general maintenance practices such as lubrication and testing, and preventing undue wear and tear. Repairs include activities to rectify or fix a certain property component so it will continue to be operable. And last, replacements are when the replacement of a property component is deemed necessary under the lease. Industrial property replacements and some repairs would be deemed capital items under GAAP and treated accordingly by the parties.
All three types of maintenance can be performed in different areas and on different components of a property. A free standing, single-tenant building may describe maintenance responsibilities completely within one property or Premises under a lease while the lease of a multi-tenant building would typically describe maintenance responsibilities under the Premises and Common Area. Within the Premises or Common Area may be components, such as the roof, HVAC, and parking lots, that the tenant or landlord would maintain.
Maintenance can be performed by the landlord, tenant, or their vendor(s). Most leases will ascribe responsibilities strictly between a landlord or tenant but there is rarely any restrictions on whether they can hire a qualified contractor to fulfill their obligations. In addition, the same party does not need to perform and pay for the cost of maintenance. For example, the landlord or their vendor can be responsible for the maintenance of the premises and can charge the tenant for the expense. Such is the case with common area maintenance charges, since it is impractical for a tenant in part of a larger building or property to maintain the common areas of said building or property. Therefore, the landlord will maintain those areas and bill back the cost of doing so according to the tenant’s prorated share of the property.
Lastly, leases usually have performance standards for the parties responsible for maintenance. A tenant may be responsible for keeping the premises clean and the roof free of debris at all times. A landlord may be responsible for fixing any roof leaks within a certain period of time. Well-defined lease provisions regarding maintenance obligations can insure against any confusion about who is responsible and the timeframes in which they have to complete their obligations.
How Industrial Tenants Should Think About Industrial Property Maintenance
The primary consideration for the industrial company regarding maintaining a leased property is their use. How the industrial company will operate in a building or on a property should inform how they structure property maintenance responsibilities with the landlord. There are several reasons why use is the key consideration for property maintenance:
- Use can dictate which party performs repairs or replacement
- Use can predict the amount of utility for specific property components
- Use can identify points of emphasis in maintenance obligations
Certain uses, such as those with high levels of security, will dictate that all property maintenance be done solely by the tenant or its approved vendors. These uses are common in property leased under an absolute triple net structure, where the tenant is responsible for all maintenance, repair, and replacements. Other uses lend themselves to sharing maintenance responsibilities with a landlord depending on the property component in question.
Some uses have such a significant amount of utility on certain property components that they only make sense for the tenant to maintain them. Data centers, for example, may be owned by an investment group with maintenance responsibility for everything other than electrical service and the IT infrastructure, which the tenant maintains for obvious reasons. Tenants in truck terminals may assume maintenance responsibility for dock equipment and yard areas since those areas are critical for their operations and are subject to greater wear and tear than other property components.
Similarly, use can help identify areas of importance when considering maintenance obligations. A manufacturing operation will likely want to prioritize the maintenance of utility services, employee services, and climate control where the warehousing operation may care more about dock equipment, truck yards, and warehouse floors.
Expected occupancy is another important industrial property maintenance consideration tied to use. Industrial companies will typically want to structure property maintenance obligations differently under a short-term lease versus a long-term lease. For example, companies will want to limit responsibility and cost for capital repairs or replacements in a short-term lease because they will likely have a very limited time in which to benefit from such costs.
Many industrial companies negotiate maintenance provisions with landlords with a focus only on cost reduction and limiting the amount of their maintenance obligations. The errors in such a strategy is it is usually not informed by the needs of the business, it assumes such costs would not be spread to other areas by the landlord, and it could result in additional unnecessary management costs. Property maintenance is not free.
Instead, the focus should be on reducing overall risk to negative outcomes such as unforeseen cost increases and operational disruptions. One of the best ways to reduce such risks is to employ a due diligence strategy. Regardless of who is responsible for maintaining a property component, industrial tenants should evaluate the condition of major property components including their age, repair history, current condition, and an expert opinion of their useful remaining life.
Landlords should be asked for answers to property condition questions before the tenant commits to any maintenance responsibilities. Any property components that are towards the end of their useful life or are in disrepair prior to the lease being signed should be replaced or repaired at the landlord’s expense according to a mutually acceptable schedule. Landlord’s limited warranties and delivery conditions are not a substitute for such due diligence.
In addition to due diligence, tenants should also look to limit their liabilities for repair or replacement pass-through or direct cost increases under the lease. Concepts such as caps on cost increases, caps on per occurrence or aggregate repair/replacement costs, reserves, and amortization of repair costs can help reduce the risk of significant unforeseen maintenance costs during the lease term. At a minimum, tenants should decline any liability for capital replacement costs which exceed the cost to replace divided by the number of months remaining in their lease term.
Performance requirements are also a significant consideration in negotiating property maintenance obligations under a lease. Regardless of responsibility for maintaining a property component, there should be a reasonable timeframe in which the component should be repaired or replaced by the responsible party. Tenants should pay particular attention to the timeframes in which a landlord is required to repair or replace. In addition, negotiating tenant rights to repair a property component which is the landlord’s responsibility should be incorporated into leases. This will provide the ability to quickly perform a required repair when the allotted timeframe for the landlord to make the repair has expired.
Lastly, industrial tenants typically have limited resources to dedicate towards the management of property maintenance. Unless the company is a large organization with a facilities management department, maintaining leased property can be a distraction away from the company’s true purpose for its employees. Therefore, most industrial tenants should try to limit their responsibilities for maintenance wherever reasonable and outsource remaining tenant responsibilities whenever possible. Unfortunately this may mean paying a little higher management fee to a landlord or entering into several different maintenance contracts, but such things should be weighed against the cost of diverting attention from the company’s primary objectives.
Summary of Maintenance Best Practices for Industrial Tenants
In closing, few provisions in a lease can impact an industrial tenant’s operations more than property maintenance. In this post I have outlined ways industrial companies can approach the maintenance of their leased properties and avoid negative outcomes during their lease terms. In summary, these concepts are:
- Consider how the company’s use of the property can or will impact how it is maintained
- Focus on reducing the risk of operational disruption and unplanned cost increases
- Have a due diligence strategy regardless of who is responsible for maintenance
- Negotiate terms which limit liability for repairs and replacements
- Insist on clearly defined performance standards for repairs and replacements, and the ability to repair or replace if agreed upon timelines are not met
- Consider available resources and try to align operational priorities with maintenance responsibilities