With a Lease, The Devil Is In The Details
by Tim Knox
Copyright © 2005
In the last article we looked at a few of the things you should consider before leasing that first office or storefront for your business. To recap, you should not only consider the old standard "location, location, location," but also consider things like sufficient parking, the number of employees who will be working onsite, and future growth projections. I stressed that it was important not to get caught up in the moment. You should take your time to find the space best suited for your business for the long haul, not just for today.
This week we'll discuss the most important aspect of the process: signing a commercial lease (insert dramatic music here). One of the biggest mistakes many entrepreneurs make when leasing commercial space is not reading the lease. Forget reading the fine print. When it comes to a lease its ALL fine print.
Don't believe me? Let me tell you the true story of my friend, Homer, whose name I have changed to protect the ignorant. Homer signed a two year lease on a suite of offices for his business. As the owner of the business Homer signed on the dotted line and agreed to personally guarantee payment of the lease and to abide by its terms. Homer moved in and it was business as usual until the end of the two year lease term drew near. It was then that Homer discovered that failing to read the lease was going to be a very costly mistake.
Toward the end of the two year lease period Homer decided to relocate, but when he gave the landlord what he thought was the customary 30 day notice, he discovered that the lease had automatically renewed for another two year term at the 60 day notice point. In other words, Homer didn't realize that the lease required a minimum of 60 days notice to let the landlord know that the lease would not be renewed. Because Homer did not know that he was required to give at least 60 days notice of his intent to vacate, the lease automatically renewed for another two years. And there was not a darn thing Homer could do about it but reach around and slap himself in the back of the head for not taking the time to read the lease.
What was the landlord's position when Homer pointed out that he had not read the lease and therefore was not aware of the 60 day notice? The landlord, while sympathetic to Homer's plight, stuck to his guns and told Homer that he would have to honor the lease, which meant that even if Homer moved out as planned, he was still on the hook for paying the rent for another two years.
Does the fact that the landlord chose to enforce the lease agreement rather than let Homer off the hook make him an evil man? Not at all. From the landlord's point of view, he had no choice but to enforce the terms on the lease. He had a signed contract that told him his space was going to be rented for the next two years. He had not planned on the space suddenly being vacant. Being a landlord with unrented space is like being a business with no paying customers. Empty space means no revenue from rental fees which means no money to pay the mortgage payment. As the old saying goes, "It's just business..."
Sure, any landlord with a heart might feel bad that Homer was ignorant of the auto-renewal clause, but not so bad that they are willing to risk their own financial well-being by having Homer's space sit vacant. The bottom line is this: whether Homer read the lease or not is irrelevant. Homer signed the lease, thereby agreeing to its terms, and therefore he must hold up his end of the bargain, period.
As of this moment, Homer is relocating his business in spite of not being able to get out of his old lease and he will continue paying the payment on the vacated space for the remaining two year term of the lease or until he can sublease the space. Even then Homer is not fully off the hook because he will still be considered the legal tenant unless his sublessor agrees to sign a new lease with the landlord. Hopefully he will just have someone else making the lease payments.
Again, the moral to this story is READ THE LEASE. Or even better, have an attorney read it for you. I have learned over the years to never sign a legal document of any kind without letting my attorney review it, especially if the document involves money and my first born child.
Here are a few other points to ponder before signing a commercial lease.
How is the lease payment calculated? The most basic equation for calculating a lease payment takes the number of square feet times the cost per square foot, then amortizes that over a 12 month span. For example, if you have 1,000 square feet and the cost per square foot is $12, the annual lease payment would be $12,000. Divided by 12 months the monthly lease payment would be $1,000. Again, this is a simplified scenario. These days most commercial leases include additional factors that affect the final price, such as rent increases, operating expense escalations, common area charges, etc.
Who pays for what? It's important that you understand exactly what you are paying for. Are you responsible for any costs other than the rent? Will you be responsible for paying your own utilities, for example? Will you have to pay for parking privileges or janitorial service? Who handles maintenance and repairs?
Is there an escalation clause? It is typical that the lease contain what's known as an escalation clause that allows the landlord to pass on increased building operating expenses to the tenants. If your lease contains such a clause you should ask for a cap on the amount the lease payment may rise over a given period of time. And if the escalation clause is ever activated by the landlord you are well within your rights to ask for an itemized accounting of the expenses that are being considered as cause for your raise in rent.
What rent increases might there be? One very important factor to know is this: if you do renew the lease how much can the landlord go up on the rent? It is expected that rents will increase as property values increase. If your landlord can rent the space for more than you agreed to pay a year ago, he is within his rights to ask for the increase. However, it would be a nightmare if your rent suddenly doubled overnight. Negotiate the increase before you sign the lease. Most rent increases are calculated by percentage, not by flat rates.
Renewals and terminations. Most leases require that you give a minimum of 60 days notice if you intend to terminate the lease and vacate the property. As Homer learned, many leases also renew automatically for another term unless you give notice within 60 days of expiration. Know when your lease expires and the time required to give notice.
Is a personal guarantee required? What happens if your business goes south and can no longer afford to make the lease payment? Are you then responsible for paying the rent out of your own pocket? Probably so. Most landlords insist on a personal guarantee from the owner or an officer of the business. This means that even if you go out of business you are still personally on the hook for the remainder of the lease.
Finally, clarify all points. You should be clear on every point in the lease. And if you are not, ask for clarification. Exactly what space are you leasing? Who is responsible for repairs? What common areas will you have access to? Who is responsible for maintaining the little things, like keeping the shared restrooms stocked with soap, towels, and most importantly, toilet paper.
A small detail to consider now, but not when you suddenly find yourself without such amenities at the wrong time.
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