What Do You Know About Commercial Leases
It's been a tough couple of years digging your small business out of the dirt from absolutely nothing. Nobody said it to your face, but you knew there were doubts about whether you could actually do it. Heck, you didn't know if you could do it.But you did. And now it's time to grow. You need more room and an employee or two. No more home office for you. From now on, we can color you downtown.
It's way cool when every waking minute doesn't have to be spent thinking about survival. When you can actually allow yourself, if only during a lunch break, to imagine leasing a little square footage next to neighbors who are more likely to borrow a ream of copy paper than a cup of sugar.
Nothing against being home-based. God bless your home office. You wouldn't be where you are if you hadn't started that way. And you're going to keep the home headquarters open, for nights and weekends. It's just time to go, and you are ready.
This present passage reminds you of when you were working on starting your business. The research days. New possibilities beget new adrenaline. It's a familiar rush and you like it.
People will actually be able to drive or walk by your new location and see your company name up in paint. "Take that!", all of you who doubted.
Now all you have to do is find that special space, within your budget, of course, sign the lease, and rock and roll. Right?!
Wrong, beeper breath! What do you know about a commercial lease?
Don't talk to me about some apartment lease you signed in college, or when you first got married. The difference between that lease and the one you are going to sign for commercial space is like the difference between lightning and a lightning bug. That lease was two pages - this one may be twenty pages.
When you started your small business you did your homework, didn't you?! You checked the market, the industry, the competition, pricing, technology, etc., etc. And you asked the advice of those who know more about the subject than you, including professionals like attorneys and CPAs.
So why aren't you applying the same discipline and due diligence to the binding contract you are going to sign for your new digs? Yeah, I know it's called a lease, but that's just a smarmy way to say contract. Lease is a euphemism for "Oh, you didn't know you are required to pay to fix the A/C? If you move out, looks like I'll see you in court."
Let me ask you a couple of questions: Do you know what a "net lease" is? What about a "triple net lease"? I didn't think so. You ever heard of incremental rent? Common area maintenance? There, there, don't fret. I'm not trying to take the fun out of your new plans. I just want to make sure you do this downtown thing successfully.
Now that I have your attention, let me introduce you to a friend of mine. Sarah Calvert is an attorney who focuses her practice on small businesses, a member of our Brain Trust, and frequent guest on my show. During one visit we talked about commercial leases.
Sarah and I agree that one of the keys to successfully leasing commercial space is to not fall in love with any one place. Find two or three spaces that would work. If you have more than one option, you accrue many benefits, including:
1. You can walk away from a deal that isn't at least fair, if not in your favor. In any negotiation you will never know how good a deal you can get until you are prepared to walk away.
2. Commercial real estate leases are like belly buttons - each one is different. Ask for a copy of the lease after a space becomes a possibility, but long before you fall in love. By the time you've seen several spaces and read several leases, your commercial lease IQ will go up a hundred points.
3. When landlords know they are in a competitive situation, advantage you. If you fall in love with one space before you know if the terms are acceptable, that sharp pain and pulling pressure you feel in the side of your mouth is your future landlord setting the hook, and your new nickname is Mullet.
Sarah says the best way to keep your commercial lease due diligence simple, while getting to the heart of the matter, is to ask these two questions:
1. Who takes care of what?
When the roof leaks, who fixes it? When the wiring goes haywire, who fixes it? When the air conditioner or the furnace goes on the blink, who fixes them? Who shovels the snow? Who mows the grass? There are dozens of other similar questions that need to be asked. How many do you know?
2. Who pays for maintenance and repair?
This is different from who is responsible for getting things fixed. Your prospective landlord may say he will get things fixed, but what he might not say, and what your lease may clearly state is, who pays for the repair or maintenance.
You must ask both questions. Fixing and paying are not necessarily the same things.
Here are some other critical questions:
Who pays the utilities?
Who pays the insurance, including liability and property/casualty?
Who pays the real estate taxes?
Who pays for any municipal or other assessments?
By collecting answers to these and the many other questions that should be asked of a prospective landlord, you will find out what kind of lease you will be signing. Is it a full service lease, as Sarah calls them, where the landlord pays all expenses, and the tenant just pays one fixed rent amount? Or is it a triple net lease, where the tenant(s) pay for everything directly, except the basic debt service. And of course, there are thousands of variations of commercial leases which are in between these two. Remember to ask who fixes and who pays!
The Square Foot Story
Typically, commercial lease pricing is based on square foot rent per annum. When you ask a leasing agent or landlord "how much?", they will say $8, or $14, meaning the price per square foot per year. Then take that dollar amount and multiply the square footage of the space you are looking at to arrive at the annual base rent commitment. Divide that number by 12 to get the monthly base rent.
Make sure you know if the square footage you are given is inside, useable square footage, or if the landlord took measurements on the outside. You want inside numbers. Take your tape measure and do your own measuring.
Comparables Analysis
As you review the prospective leases and gather answers to your questions, create a comparables analysis. This approach will help you compare dissimilar properties and leases. A comparables analysis begins as a list of specifications, features and responsibilities on the left side of a ledger, with the prospective properties across the top, over the columns.
Once identified, determine the cost of each specification, feature and responsibility for a year. For long term leases, you might even want to anticipate the affects of market fluctuations and inflation on incremental rent components. When you are finished, just add up the columns for each property, and that's your annual financial valuation. Divide that annual total rent by the square footage, and that's your real annual square foot rent, which is different from the base rent the landlord gave you, except in the case of a full service lease.
Now you can evaluate several properties with different lease terms by using square foot rent as a market comparable, and you can use the annual financial commitment for budgeting.
One excellent way to collect good data, and keep the landlord honest, is to talk with your prospective neighbors. Just tell them you are thinking of moving to the general area, not necessarily their building. You will be amazed at how much strategic info you will get from these folks that will help you make your decision.
It isn't possible in this space for me to cover all of the things you need to know to negotiate a successful commercial lease. How do you learn what questions to ask? Experience and research helps, but you probably need a professional advisor.
Attorneys are the best people to evaluate a lease. Some of the best money you will spend is having an attorney review the lease contract you are considering.
Think Business, Not Emotion
Renting an office is not like buying a house. Office rental should be more of a business decision than an emotional one. But I know what you're going through. I remember the emotional side of this process. Just do yourself a favor and make the comparables analysis first, then you can dial in the emotional aspects.
If one property is a dollar a foot higher than another but more appealing to you, and you can afford the extra expense, go for it. But just think how much more comfortable you will feel about what might be considered an extravagance if you know exactly how much you paid for it.
Write this on a rock... When renting office space, make sure you look at all available market options and create a comparables analysis. Commercial leases are like belly buttons - they are all different. You must apply sound due diligence fundamentals as you compare different properties and leases. Then let your attorney read the lease BEFORE you sign it.
