Leasing Or Buying Real Estate

What You Should Know Before Leasing or Buying Commercial Space

Leasing or purchasing the right commercial space can greatly influence the long-term success of a business.  Depending on your business type items such as freeway access, visibility, demographics of an area, signage and parking are important considerations.  For medical professionals, proximity to a hospital may also be a critical factor. 

To minimize time pressures of making a move, it may be prudent to begin the selection process about 6-18 months before you need to move.  If you are interested in new construction or will need to reconfigure existing space you may need to start your search more than 12 months in advance to avoid any penalties of staying in your space after your lease expires.  You should check any existing lease you may have for a holdover clause that will detail if your rent will increase by staying in your space past the expiration date.

When leasing or buying space, you should immediately develop a relationship with a qualified commercial real estate agent who has experience in the type of commercial space you need (office, retail or industrial) and who is familiar with appropriate properties in the locations you want.  Choosing the right broker is essential because this individual will work on your behalf throughout the leasing or purchase negotiations.   In today’s market there are many incentives that may exist whether leasing or buying and engaging the services of an expert will benefit you in negotiating the best rate.

Letter of Intent
Once you select the space that meets your needs, your broker will work with you to draft a non-biding letter of intent that serves as the basis for a lease or purchase agreement.  For tenants, the letter will address the rent, length of the lease, security deposit, tenant improvements and timeframes, etc.  For purchasers, the letter will detail the purchase price terms and will include a timeframe for inspections and finalizing finance arrangements, including obtaining an appraisal and any other documentation a lender may require. 

Tenant Improvements
Depending on the condition of the space, a tenant improvement allowance on a lease usually ranges from $5 to $10 per square foot for existing finished space to $30-$45 for shell space.  If the landlord handles the improvements, the allowance will be paid directly to the contractor.  Any amount over the agreed upon sum is paid by the tenant, typically as a lump sum or as an amortized amount added to the rent.  If the tenant is handling the improvements, the agreed upon amount may be covered through a negotiated rent reduction.  All these variables should be covered in the letter of intent.  Often times the tenant improvement allowance will also depend on the specificity of the improvements and the length of the lease term.  Purchasers are generally responsible for making all needed improvements to the building unless otherwise negotiated or determined within the feasibility period. 

Purchase Agreements and Leases
Once the letter of intent has been approved, the purchase agreement or lease is drafted.  You may choose to have it reviewed by your attorney. 

The purchase agreement includes the terms agreed upon in the letter of intent, as well as other details pertaining to the purchase.  The due diligence period involves a review of the property, property documents, securing financing and coordinating space planning.  Due diligence typically requires at least 30 to 60 days.

In lease negotiations, there are basically three types of leases:

NNN lease – Operating expenses are billed back directly to the tenant based on the company’s share of the building’s square footage, these costs include property taxes, property insurance and common area maintenance.  Tenants also pay for their own utilities and janitorial services.

Modified growth lease – Tenants pay for their utilities and janitorial services, but the landlord pays the operating expenses, adjusted for a base year or expense cap.  If the operating expenses rise after the base (first) year of the lease, the tenant will be responsible for covering the increase.  If an expense cap is employed, the landlord pays a fixed amount per square foot.  If the actual operating expenses surpass this amount, the tenant is responsible for the difference. 

Full-service lease – The landlord pays for utilities, janitorial services and operating expenses, adjusted for a base year or expense cap. 

To protect your interests, your agent may specify in the letter of intent that operating expense increases resulting from a base year or expense cap will not exceed 3 to 5 percent a year for controllable expenses.   

There is an infinite number of different ways to negotiate commercial space to meet your needs.  In addition to those already mentioned, in today’s market there is a need to be more and more creative to include approaches such as seller financing, leasing with an option to purchase, first rights, subleasing etc.  For more information and assistance with your commercial real estate needs, contact Barbara Lloyd with Prudential CRES.

Barbara Lloyd, CCIM
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