The Complete Guide To Negotiating A Commercial Lease

When negotiating a commercial lease, it’s common to just consider the rental rate alone as a negotiable factor. Although there are a range of other factors to negotiate as part of the wider commercial lease. They can be financial and non-financial aspects to protect your security of tenure, save money, and provide flexibility during the lease. 

We will discuss the most important points to cover when negotiating a commercial lease contract. Both parties confirm the terms in a letter of intent (LOI); thereafter, the drafting of the formal lease can start.

TOPICS TO BE AWARE OF WHEN NEGOTIATING A COMMERCIAL LEASE

NEGOTIATING THE PRICE OF A COMMERCIAL LEASE

With the rental rate, you are negotiating what rate fairly reflects the market. Landlords will always try to push for an above-market deal to push rents up over time. The use of tenant representatives helps occupiers ensure they are getting a market rate.

There will commonly be a face rent, which will be the rental rate in the agreement. Although the effective rent is what should be the main consideration. It reflects all the commercial terms negotiated in the agreement. Such as rent-free periods and landlord contributions. If the market rate and the landlord’s offer are some distance apart. The use of concessions can generate an effective rental rate that reflects the market level.

The negotiation of price is done through the use of comparable evidence in the market of similar transactions. Landlords try to make this evidence as opaque as possible to increase values. The use of agents by tenants is valuable, as they should know the effective rates behind comparable evidence.

NEGOTIATING FINANCIAL CONCESSIONS FOR A COMMERCIAL LEASE 

Landlords will make concessions in order to secure a tenant by sweetening the deal for them. The following are common terms that reduce the effective rate calculation in line with the market: These commonly come in a couple of forms:

Term 

The lease term is one of the most important aspects to establish for an incoming tenant. A tenant will have to fit out costs for the space at the start of the lease to suit their operations. The term and subsequent rights to renew need to justify capital expenditures to start the lease. The term needs to be commercial, especially if the tenant doesn’t have an automatic renewal right.

As a rule of thumb, if the tenant fixes the term for longer than normal, the rent should reduce. This provides the landlord with a longer period of rent guarantee. Moreover, a shorter fixed term provides less guarantee, and so the higher the rental rate the landlord will likely offer. 

Landlord incentives 

These are financial pledges that the landlord signs up for within the lease. Sometimes the landlord’s commitment is written in a separate document to reduce transparency for future deals. They make the tenant’s move simpler and reduce the effective rate the tenant pays over the term of the lease. They are highly negotiable and can take the form of the following:

• Landlord providing fit-out contribution
• The landlord provides a contribution that has no tie to its use.
• The landlord pays the tenant’s brokerage fee.
• The landlord reduces the reinstatement obligation if the tenant stays for a certain amount of time.
• The landlord carries out certain work on the property prior to the lease commencement. 

Rent-free periods

Another way to create value is through rent-free periods. Rent-free periods to help tenants with the initial setup of the space. Alternatively, at the end, when a tenant may be moving out of the property. This can vary depending on markets and landlords, but adding rent-free to an effective rate calculation reduces rent over the term.

 

Whereas, set annual increases can keep the rent lower than the market. If the market grows in excess of the set increases prescribed in the lease. The balance of this addition is dependent on your future view of the market forecast. Your effective rate will include the set increases, although the market rent reviews are hard to predict and are left out.

Building signage 

If it is important for a company to have their logo or name displayed at your location, you can negotiate signage rights.

Depending on the type of building, this could be free of charge or could be a very valuable advertisement for the tenant and would be discussed on the concession page. This needs to be discussed at the proposal stage, and generally, that comes more easily to larger, long-term tenants. 

TOPICS OF NEGOTIATION FOR OPERATIONAL & LEASE FLEXIBILITY

There are other non-financial aspects that can create value within a lease, which will give flexibility to adapt the lease in the future.

Parking  

Parking varies depending on the facility you are negotiating with; the CBD of a city will be tight, whereas a less urban site may have more. Depending on the requirements of the tenant, this is an aspect that can be negotiated as part of the concessions in terms of rental values and any discounts available. Furthermore, in regard to time usage and the number of spaces.

Expansion right of first offer (ROFO)

If a tenant plans to grow, the use of expansion clauses adds non-financial value to the tenant. This gives the tenant the first right to take a floor that comes available in a building before the landlord markets the space. Unless you’re a large tenant, this will not be for the whole building and will likely cover the adjacent space above, below, or to either side.

Right of first refusal (ROFR)

This is the right to refuse a new tenant in the vicinity of your business. If a competitor is enquiring in another space close to yours with the same landlord, this clause allows you to refuse tenancy. This is only likely to be agreed upon by landlords for retail tenants.

 Subleasing

is the right to rent the space under the lease out to another party if, during the term, it doesn’t suit your requirements. For instance, if you relocate to a larger location before your lease expires. Or you downsize and no longer need part or all of your space. This is a great way to save money on used real estate and also make a profit, depending on the market and how the lease is written.

Renewal right

Having the right to renew your lease is important to protect you when your lease expires. A renewal right gives you first right to your space and prevents the landlord from leasing it out from under you. This is slightly different in the UK. By ensuring the lease is within the Landlord and Tenant Act 1954, the tenant will have automatic renewals for the occupation of the building. Like rent reviews, a cap and collar can be added to the renewal. This is to ensure the rent has a cap to control the level it can increase by, which is helpful for a tenant. Alternatively, a collar will stop the rent from dropping to far below the current rent if you’re a landlord.

Break clauses

A break clause is a good option to consider if either side is pushing for a longer term, but you are only willing to commit for that period of time. With a break clause, you can commit to the longer term, but with the flexibility of exiting at a certain point within the term. For example, a 7-year lease with a break option after 3 years.

Reinstatement obligations

The reinstatement obligation is to ensure the tenant leaves the property as they found it. Normally, any work the tenant has done to the building for their use of the property needs to be restored to its original condition at the end of your lease. This is negotiable and can be capped or completely abolished if the tenant stays for a certain period of time.

THE KEY DRIVERS FOR THE DIFFERENT PARTIES INVOLVED IN THE NEGOTIATION

It’s unlikely to negotiate these aspects all into one lease. This guide gives a broad knowledge of financial and non-financial tools you can use to negotiate the best terms for your situation. Although which of these tools you use depends on whether you’re a landlord or tenant and any specific qualities you bring to the table and priorities you have. The aim is to balance the financial elements to reflect the market rate and the non-financial terms that align with other goals.

Landlord 

Real estate funds: They might want a high face rent in order to keep a high capital valuation for the building but would be willing to have more financial incentives.

Private landlord: They may want more secure, long-term tenants with good covenants, and so they would offer a lower rate if the term commitment was longer.

Retail mall landlord: These landlords may be looking to create an experience for shoppers. As a result, would be willing to give reduced rent to an anchor tenant who would bring footfall and potentially rights of refusal for neighbouring space.

Tenants

Tenants who are growing rapidly: For a company in growth mode, it’s hard to predict requirements in the future, so flexibility is very important. The use of break clauses, expansion rights, and subleasing might be appealing to this tenant.

Large stable tenants: They are able to predict the future and can be more confident in committing for a longer period of time. They may push for more value in landlord contributions, renewal rights, and rent review caps to maintain the location and control future price hikes.