In today’s high vacancy market tenants need to pay careful attention to operating expense structures in commercial “gross” leases where the tenant pays a base rent plus increases in operating expenses based on their percentage of occupancy. Under gross leases where expenses are included in the base rent, tenants need to make sure that the “base year” defined in the lease is “grossed up” to reflect at least 95% occupancy even if the space is mostly vacant today. Failure to do so can result in base year expense profile that is artificially low resulting in heavy pass through expenses to tenants in later years as expenses increase to operate the building. For example, if the landlord has cut back on janitorial, HVAC, security, maintenance, and other operating expenses as most the space is vacant, and this expense profile is used to set the base year, tenants in later years will see a dramatic increase in their rent as costs rise with more and more occupancy.

Because the base year expenses are used to calculate the tenant’s liability each year of the lease, this overstatement will occur every year of the lease term if the building remains fully occupied.  This creates an annual windfall for the landlord at the tenant’s expense. To compensate for this issue, look to set the base year expense profile as if the building was at normal to full occupancy levels. Note that not all expenses are variable and some are fixed. If the cost is fixed it will not change with increases or decreases in vacancy.

• the length of lease you will entertain


• how the space is to be delivered by the landlord at the landlord’s sole cost and expense proposed occupancy date


• leasing concessions such as free rent, a tenant improvement allowance, moving cost allowance, furniture allowance, early lease termination provisions, etc.


• a “drop dead” date for the landlord’s response

• After reviewing responses back from the various landlords to your counterproposals, it is time to get your senior management together and review proposals to determine the finalists based on you and your broker’s recommendations.  Update earlier financial models and be prepared to address a series of questions regarding anticipated costs, risks, rewards, and why these buildings are better than any of the others you looked at or received proposals on.



• Prepare your final and best non-binding counterproposal(s) asking each landlord to include a draft lease with its response.  If you like one building more than any of the others (this happens most of the time) you should consider asking the landlord to take the building off the market as you negotiate a lease in good faith.  Obviously at this point you only want to be negotiating on buildings that you can realistically move into on time and on budget.  The counterproposal stage may go a few rounds and include verbal negotiations.  Work with your broker to ensure that you have an executed non-binding term sheet that the parties can rely on to review the lease against.

• the base rent and rental escalations if any


• all expenses associated with operating the building and who pays for what expenses


• who handles building repairs and how those expenses are paid for


• the treatment of future capital improvements


• the payment of real estate taxes and insurance expenses


• the tenant work letter and how the building and space will be delivered to the tenant


• building use provisions including rules and regulations


• sublease/assignment rights


• tenant audit rights with respect to building expenses passed through to the tenant


• determining fair market rent for options to extend the lease term

Space exploration - Consider more than cost

With the uncertainty of how long low rates will hang around, you may be tempted to commit to the offer with the lowest price tag. However, there are factors that can inflate your actual cost. Utility, maintenance and improvement fees can hide within a hastily signed document.

A careful review with a real estate professional can weed out deals that are too good to be true and help you bargain for favorable terms. For example, a clause that ties rent increases to tangible market figures can avoid exaggerated rate spikes. You can also work to include exit or expansion options.

“Some of the variables to consider when analyzing a new lease include cost, flow-through obligations, taxes and maintenance,” says Martin Pupil, senior managing director, Colliers International Orange County. “I strongly recommend to companies that they get their attorneys involved and partnered with their broker to find out how they can properly use their leverage with a landlord to get a better deal.”

Many property owners are struggling financially, so it is imperative that you research the stability of the landlord. If the building goes into foreclosure, you may be liable for additional costs or be shuffled around by a new owner.

“When a tenant is moving into a building, it’s like a marriage,” Strasmann says. “You’ve got to feel comfortable with the ownership and the ownership has to feel comfortable with the tenant. You’ve got to make sure they have a good reputation and they run their properties with quality and they have a good reputation in the market.”…Click HERE to view the full article.

Source: www.sbonline.com