Commercial Leasing

Commercial leasing, as the term implies, is deals with the rental of business and commercial property, usually for lengthy terms. What differs commercial leasing from residential leasing are the distinctive issues that business operations present to both lessor and lessee.

Residential leases are often for a year or less, even though they are usually renewable. This gives the residential property owner the option to increase or decrease rents as market conditions, taxes, and expenses change. Neither owner nor renter is locked into a bad deal for more than a year before either can easily opt out. The result of a bad deal for a residential tenant is limited, for the most part, to the hassle and expense of finding and relocating to another apartment.

The consequences of a bad deal between a commercial lessor and lessee can be significantly greater. Becoming established in a good location is crucial to the success of any business. When established and successful, the businessperson is likely to settle in for a long time. Commercial leases commonly run five, ten, or even twenty years. A lease of one year is a rather short term for a business. A commercial lease needs to be adaptable to fluctuating market conditions. When negotiating a commercial lease, a critical matter will be to balance the tenant’s need for certainty in rent and costs with the landlord’s need to be able to increase rents based on increased operational costs or demands in market conditions. Provisions in a commercial lease might include the following:

• A rent-escalator clause, which would tie rent increases to inflation or average market rates. Rent may be tied to the tenant’s income. Rent is commonly increased annually. The rate increase might be proportional to the consumer price index for the previous twelve months.
• A proper lease should indicate the party that will be liable services and utilities, such as electricity, heat, water, snow plowing of the parking lot and sidewalks, trash pickup, and custodial services.
• The landlord may require a term that allows upward adjustment in rent to reflect increases in taxes, utility costs, and similar expenses.
• Commercial leases will often indicate what the property may be used for and place limitations on assignment and subletting the lease.
• Properties housing several tenant businesses can face issues of parking, storage, access, and nuisance between tenants. The commercial lease should address any relevant issues explicitly.
• A substitution clause can allow the landlord to relocate the tenant to another space in the same building, as long as the space is reasonably equivalent and the landlord pays for the move. The substitution clause is supposed to allow the landlord to accommodate future tenants with a need for large blocks of adjacent space, thereby creating the most efficient use of space.
• If the tenant needs to modify the rental space, the landlord may want to reserve the right of final approval of renovations. Build-out allowances may be included as an incentive to new tenants.

Backing a Lease with a Personal Guarantee

Commercial leases are often not between landlord and individual person but rather between landlord and legal entity, such as a corporation. Small and startup businesses can run into trouble trying to lease new facilities, especially when the business is not yet creditworthy.

As discussed earlier, business tenants very often negotiate lengthy leases to ensure certainty and stability over a longer period of time. However, when the business does not have a credit history, the landlord may be hesitant to rent space to the business. Since many business organizations shield the people behind the entity from liability, landlords may worry about what will happen if the corporate tenant goes out of business. If the corporate tenant has no assets the landlord can recover from and the people who ran the business are not liable for breaking the lease, a landlord may have no recourse if the business fails.

By requiring a personal guarantee from the persons who own or run the business, the landlord has recourse if the business fails. A personal guarantee means that the landlord can go after the guarantors—the shareholders, directors, or officers, for example—if the business must break the lease.

Landlords should always require a personal guarantee while tenants should always avoid a personal guarantee. Of course, the answer is not so simple. If the landlord needs the tenant more than the tenant needs the space, then the landlord might not push for a personal guarantee. And if the tenant is in a tight position and the landlord could find plenty of other renters, then the tenant and the people running the business may have no choice but to make a personal guarantee.

The personal guarantee is a provision that can be negotiated. If the landlord is adamant about requiring a personal guarantee, then perhaps the business owners can negotiate a personal guarantee that covers the first year or more of a multiple year lease but not the entire lease. Or perhaps the owners can negotiate a guarantee that will pay a portion of the rent if the business fails if the landlord can show that the landlord is making reasonable efforts to replace the tenant.