Wednesday, August 01, 2007

[New Biz] The Office Lease: Practical Considerations

I signed the commercial lease for the office space. I'm no Real Estate lawyer, so I'm not going to get into any of the nuances of lease negotiation or legal terms.

Of course you know that if you plan to rent office or retail space for your business, make sure you have a Real Estate lawyer take a careful look at the lease (duh). More importantly, make sure the person reviewing the lease is familiar with the local laws, rules and practices in your specific area.
So for example, if you use a law firm in Manhattan but are renting office space in a satellite office in Rochester, hire a firm in Rochester to negotiate your lease.

I had a lawyer-colleague review the lease and it cost me less than $2,000. This is someone with big-NYC-firm experience who has her own solo practice now. I've heard lease reviews and negotiations costing $10,000+ as well. It depends what you are leasing and the law firm you hire.

In addition to the obvious things like price per square foot and term, here are some key business items that were important to me:
  • Option to Renew. I was getting a 10-year lease. However, if I end up selling my business, it will be far more valuable to the buyer if there is an option to renew the space. If the commercial real estate market is hot when the lease expires, the landlord could ask the business to leave after the lease expires. If suitable space is not available, there's no business. The option buys the business another 5 years.
  • Landlord's Obligation to Pay Build-out Expenses. The landlord is paying for the build-out (well, actually, I'm paying for the build-out over time, he's fronting the cash). I needed to make sure everything I needed him to do (and pay for) was in the lease. There's no renegotiating after the lease is signed.
  • Limited personal guaranty. My landlord won't rent without a personal guaranty unless he gets six months security deposit. Not exactly the best use of cash. That being said, what I guaranteed was that I would (personally) pay the rent if the business stopped paying the rent and didn't vacate the premises under the "Good Guy Clause".
  • Good Guy Clause. Without getting technical, it's a clause in your lease that lets you surrender the space without further liability to the landlord if you are unable to continue to pay for it. The Good Guy Clause was important to me because, in an economic downturn, it could mean the difference between downscaling and survival or shutting the business down and bankruptcy.
  • Relocation Rights. If we grow rapidly and need more space, our lease permits us to relocate a smaller tenant to a similar space in the building at our own expense. Of course, this right is usually reciprocal. Another tenant bigger than us may like our view better!
  • Assignment Rights. Again, if the business is sold, I don't want hassles with the landlord about lease assignments to the buyer. I have a good relationship with the management company and they are very flexible. But buildings get sold and you're always just end up stuck with your lease terms. I couldn't negotiate assignment without the landlord's consent (no sane landlord would permit this), but I got terms that won't hold up a deal if I find a buyer.
This isn't an exhaustive list of every line item that was negotiated, but it's a good start of things to look out for.

One more thing--and this was a surprise to me when I signed my first commercial lease--when you rent commercial space, you rent bricks and glass. Literally. When your landlord calculates the square footage of your space, they measure from the outside of the building not from the interior wall, plus, you pay for your space's pro rata share of common spaces, like the lobby, corridors, restrooms, elevators, mechanical rooms, etc. The percentage of the space that you are renting that is not the physical space in your office is called the "loss rate". The loss rate in my building is around 33%, I've heard about some buildings where the loss rate is 65%.

Urban legend or not, as I told my landlord when I signed the lease, the commercial real estate game is a nice business if you have the cash to get started.

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