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A landlord will generally prefer to amortize any of its costs associated with the lease over the term of the lease, rather than to pay them upfront.
The longer the lease term from a secure and rent paying tenant, the better for the landlord when it comes to refinancing and/or selling the property based off of the net operating income of the building.
From a broker’s perspective, the free rent period should be added to the desired term of the lease (rather than subtracted from the lease term), given that the longer the term of the lease, the larger its commission will be.
When advocating on behalf of a tenant on a potential 10-year deal, try to secure a 5-year lease term with a 5-year option period to provide the tenant flexibility.
Whether you represent a tenant or a landlord in a lease negotiation, it is important to recognize that free rent concessions generally are part of the equation.
In determining the amount of free rent a landlord will give a tenant, a landlord will evaluate current market conditions, the type of use (retail, office or industrial) and other concessions being negotiated such as if there is a tenant improvement allowance and the amount of landlord’s work being requested by a tenant.
Depending on the market, deal type, and other concessions being granted to a tenant, a reasonable amount of free rent for a tenant agreeing to a 5-year deal is between 1 to 2 years.
When a tenant vacates a space, the landlord will incur loss of revenue from the vacancy turnover.
Instead of asking for one hundred percent of a free rent concession to be granted up-front, to make it more appealing for a landlord to grant more free rent, tenant advocates should consider offering to bifurcate the free rent requested by spreading it out over a period of months in either full or one-half month increments.
Landlords should consider adding to its initial lease draft that upon the occurrence of an uncured default by tenant, any rent abatement, concession or other allowance given to the tenant shall be deemed of no further force or effect; and the unamortized amount (calculated on a straight line basis over the initial lease term) of any rent concession, brokerage fee or other allowance should be immediately become due and payable by the tenant to the landlord.
Tenants should attempt to negotiate that any landlord recapture provision relating to free rent should “sunset” (become null and void) after a pre-specified date in the lease (e.g., the 2nd or 3rd anniversary of the rent commencement date).
From a landlord’s perspective, the LOI should limit the ability to exercise the renewal option right, so that it is personal to that of the tenant only.
For a retail tenant, the existence of a renewal option does not make the value of its lease significantly stronger.
Tenants should negotiate for the right to exercise the renewal option by not only the named tenant, but also by any parent, affiliate, subsidiary or permitted assignee of the named tenant.
For a lease where the rent will be pre-established for the renewal term, tenants should attempt to have the landlord provide a tenant improvement allowance at lease renewal of roughly $5 to $15 PSF.
Ideally for tenants, the rent for the renewal term will be fixed and not based on fair market value (“FMV”).
As a landlord advocate, not only should you insist that the renewal term rental will be 100% of the fair market value (“FMV”), but you should also create a floor on the FMV by providing that the renewal rent shall be no lower than the net effective rent at lease expiration plus 3% to 5%.
For renewal rents based upon fair market value, tenant advocates should seek for (a) the renewal term rental amount to be 90%-95% of fair market value, and (b) the fair market value to be based upon all “relevant market factors.”
In many leases, in addition to a real estate tax escalation, among the more popular (or unpopular, depending on your perspective) rent escalation provisions are those which require the tenant to pay its proportionate share of operating expenses over a base year, and an agreed upon increase in fixed rent based upon a predetermined percentage increase.
Generally, most landlord advocates prefer a CPI or straight predetermined percentage bump in the rent as opposed to an operating expense escalation.
To the uninformed tenant (and a large portion of leasing professionals negotiating the clause), the language contained in an operating expense clause operates as a profit center for the landlord.
Decorating, snow and ice removal, and service contracts are generally not included in the operating expenses of a building.
Most operating expense definitions found within a commercial lease are extremely broad, and moreover, many include a number of costs considered to be capital in nature and contain built-in profit components.
Tenants are in the business of leasing out their space for profit, and conversely, landlords are in the business of leasing out space from a tenant to conduct their business operations in order to make profit off of such operations.
An example of how tenant advocates can lessen the way the operating expense clause can operate as a “profit-center” for the landlord is to make sure that any item of a capital nature included in operating expenses is based upon the remaining term of the lease to the useful life of the capital expenditure itself using Generally Accepted Accounting Principles (“GAAP”), and not on the useful life “as determined by landlord in its sole discretion.”
Landlord advocates should consider requiring its tenant to use a firm, which will charge the tenant for an audit of landlord’s operating statement on a contingency basis.
Tenants should attempt to negotiate that in no event shall the initial payment required by tenant relative to the operating base year occur prior to the twelve month anniversary of the rent commencement date.
Tenants who are paying their proportionate share of the increase in operating expenses over a base year don’t need to be concerned with the specific year the base operating year will be.
A strong argument can be made that when a tenant pays a percentage rent increase in addition to the fixed rent in lieu of an operating expense escalation, the landlord is actually “double dipping” and creating more profit for itself (given that the percentage rent increase is effectively applied against the landlord’s operating costs and profit margin).
Tenant advocates should insist that percentage rent increases be applied on an annual cumulative basis (instead of, for example, every 5 years).
Operating expenses never include costs attributable to wages, salaries and benefits of building personnel.
Operating expenses never include costs attributable to repairs and maintenance of the building.
Operating expenses never include costs attributable to ownership, management and repair and maintenance expenses.
Operating expenses do not include costs attributable to the wages, salaries and benefits of tenant’s employees.