Articles

Article VII "Rent in Commercial Leases 2004-2005"

At one time or another almost all businesses will have to enter into a lease for business space. One of the primary considerations in lease negotiations is the amount of rent a tenant will be obligated to pay under his lease.

In entering into such negotiations, it must be remembered that most landlords are sophisticated at renting property whether it be an office, store or manufacturing facility. Renting property is the landlord’s business. Obviously, for the tenant, the renting of space is only necessary to facilitate his or her business, which may have nothing to do with real estate. Therefore, a tenant who does not have experience in negotiating leases would need some background in order to understand his major obligation under a lease, which is the tenant’s obligation to pay rent.

When a rental quote is given, the quote usually refers to the base or minimum rent that the landlord is requesting. Further investigation will reveal that there may be various add-ons including additional rents, passalongs, passthroughs, yearly increases, percentage increases and other methods that a landlord may use to actually increase the amount of rent payable by a tenant. This article attempts to explain some common add-ons and the necessity of a prospective tenant to inquire into the extent of any additional costs in order to properly budget and estimate its cost of operating the leased premises.

The “minimum” or “base” rent in a commercial space is generally quoted at a certain dollar amount per square foot on an annual basis or it may also be quoted at a certain dollar amount for the entire premises on an annual or monthly basis. Thereafter, it is not uncommon to have one or more of the add-ons described below.

The tenant can be asked to pay a pro rata percentage of the real estate tax or a pro rata percentage of the increase in such tax over a certain base year. Usually a lease will provide for a monthly real estate tax payment to be made to the landlord based upon the estimated yearly real estate tax. Payment is then adjusted at the end of the year when the actual bills are received. A shopping center lease will often have an additional amount payable for what is known as common area maintenance charges or “CAM” This is the tenant’s pro rata share of maintaining the public grounds and areas including the parking lots and outdoor lighting.

Often a lease will contain an electric clause which requires the tenant to pay an additional amount per square foot for electric if electric is provided by the landlord; or if electric is not provided, the lease will contain metering charges.

Some leases, particularly in major shopping centers, provide that, in addition to base rent, the tenant pay a percentage rent, which is often computed as a percentage of sales over and above a certam minimum. There are many ways to draft a percentage rent clause. Such clauses could be based either on gross sales, net sales or sales which exceed a given sales base or breakpoint or various other methods which may be tailored to the landlord’s and tenant’s specific needs in business.

There can be provisions in the lease for either annual percentage increases in minimum or base rent or cost of living increases based upon either consumer price indexes in a given area or other indexes which are agreed upon between the parties. Some leases have what is commonly referred to as a “porter’s wage increase” clause which is tied to wages paid to support personnel of the landlord, (i.e., custodians, superintendents, etc.), as fixed by collective bargaining with a specific union.

In determining most of these increases, the “percentage” or “pro rata” cost, refers to the tenant’s pro rata portion of the entire rental complex or the total number of tenant’s square feet of leased space compared to the total square feet in the complex or building. It should be noted that in computing these numbers what is used by landlords is “rentable” and not “usable” square feet, For example, in an office space the tenant’s square footage is measured from the outside of the building as opposed to the inside walls. Furthermore, the landlord will include a portion of the public lavatories, public hallways, elevator shafts, lobbies and other public areas in determining pro rata space. It can readily be seen that there can be a dramatic difference between “rentable” and “usable” space which is often as much as 15% to 20%.

What is usual, customary and standard in any particular type of lease depends upon the type of space rented, (i.e., office space, shopping center store, strip store, factory, entire building. blended or mixed-use space) and many other variables including the relative strengths and bargaining power of the landlord and/or tenant. What should be noted is that it is necessary to obtain all of this data in order to compute or at least estimate what all of these charges might be so that a tenant can properly project his costs and determine whether or not this particular spacemakes sense from a business point of view.

A lease is an agreement that a tenant has to live with for long period of time, and what might appear at first blush to be a good deal, may change radically three or four years down the road when all the passalongs, add-ons and increases have been included. This often has the effect of greatly increasing the amount of rent payable per month.

A commercial lease obligates a tenant to a substantial long-term liability. In addition, there are various other factors to be considered such as, but not limited to, work letters, renewal and expansion rights, options, reduction and buy-out rights, assignment and sublet issues, environmental considerations and defaults, just to mention a few. Accordingly, these costs and the other items should be looked at and considered with great care and advice sought from an experienced real estate attorney before concluding any transaction of this nature.

The purpose of this website is to familiarize its readers with the subject matter. The author is not rendering legal, accounting or other professional advice or opinions on specific facts and assumes no liability with the use of this information. The law is very complex and constantly changing. No one should attempt to apply or interpret any law without the help of a trained expert. The author is licensed to practice law only in New York State and any law referred to on this site is the law as it applies in the State of New York.