By: Conner G. Eversole, Esq.
Affiliated Partner – Fairfield and Woods, P.C.
Negotiating a commercial lease for your brewery, restaurant, or bar can be tricky, but it doesn’t need to be stressful. In this article, we explain the most common lease types, share some tips on how to negotiate the right commercial space for your unique business needs, and highlight other common lease terms to consider. Whether you are an experienced tenant or a first-time renter, this article will provide helpful insights and strategies to anyone negotiating their next commercial lease.
Net Lease vs. Gross Lease.
The two most common types of commercial leases are Net leases and Gross leases. Net leases can be broken into three types: 1) Single Net, 2) Double Net, and 3) Triple Net. Single net leases are characterized by the tenant paying base rent, plus some pro-rata share of the property taxes and utilities. Double net leases include the costs associated with a single net lease, plus a portion of the property insurance costs. Similarly, triple net leases (which are the most common, and sometimes referred to as “NNN” leases), include all the above costs, plus amounts associated with the tenant’s pro-rata share of the landlord’s common area maintenance (or “CAM”) expenses, which may include parking lot maintenance and landscaping. The benefit of Net leases is that, oftentimes, the base rent amount is lower to offset the tenant’s taking on the additional financial responsibilities, which the tenant also maintains some control over. If things are going well, this can be a good thing. However, if there are problems with the building, it can be a real burden.
Conversely, a Gross lease is where the tenant pays a fixed amount to rent the property, and the landlord pays all other expenses normally associated with its ownership (real estate taxes, insurance, CAM, utilities, etc.). Most residential leases mirror Gross leases. The benefit of a Gross lease is that a tenant can reasonably expect to know what they will need to pay in rent every month, and can better budget for that amount. However, it also means that tenants should expect to pay a higher base rent to account for the additional landlord costs.
You can also have modified leases, which blur the lines between Net leases and Gross leases. Landlords and tenants will often negotiate these terms to better suit their specific business needs and the conditions of the premises.
Standard Form Leases.
Tenants finding themselves in a dispute with their landlord sometimes ask what their options are, but don’t realize they are renting under a standard form lease (which almost always favors the party who drafted it). While it may seem obvious to some, many new entrepreneurs feel like they are subject to the whims of their landlords, especially when negotiating a highly sought-after location. In fact, parties to a lease may present a lease as a “take-it-or-leave-it” document. Do not be afraid to negotiate and revise that standard form lease to suit your specific business needs. Do not be afraid to negotiate the terms of your Letter of Intent, or Lease Agreement, to ensure you are getting the best deal on your lease possible.
Licensing Contingencies.
Colorado’s liquor licensing application process requires an applicant to provide evidence of an appropriately zoned and permitted location to conduct their business prior to issuing the necessary license, which creates a unique timing challenge when it comes to entering into a new lease. Put another way, an applicant needs to have a signed lease or deed in hand before the licensing authority will issue the license (but you need a license to operate the business). Tenants without the ability to terminate their lease upon finding out their license was denied can find themselves stuck in multi-year financial obligations without any exit strategy, or ability to operate. Therefore, it is necessary to confirm your lease contains contingencies that allow a tenant to terminate in the event your business does not receive the necessary operating licenses within a certain period following the lease start date.
Relocation Provisions.
Some leases allow landlords who own business centers, shopping malls, or multi-unit commercial buildings to relocate a tenant within the same building or shopping center at their discretion. Typically, this is to allow a landlord the flexibility to optimize their available retail space. However, this can be challenging for a new business trying to build its local following; plus it can add unforeseen moving expenses that a landlord may not cover. Here are some of the important considerations to protect yourself within the language of the lease:
- It is better if this landlord right is removed altogether, to alleviate any concerns that your business could be moved during your tenancy.
- If that is not possible, negotiate to have enough time to evaluate and prepare for the move, and make sure the lease language clearly states that the proposed space must materially match your existing space in design, size, amenities, and quality of finishes. This should include unique aspects of your existing space, for example, parking, utilities and access, floor level, the direction of view, or the number of dock doors. There should also be a maximum size decrease amount included in the lease of no more than 5%-10% of the existing floor plan;
- If the new space is smaller or does not match your existing space as set forth above, you should negotiate a rent decrease to only pay for the smaller square footage; conversely, if the new space is larger than the original, you should only be charged for the initial square footage occupied;
- Your landlord should cover all costs associated with relocation, such as construction and moving costs. Additionally, landlords should cover smaller costs, like changing your company letterhead, business cards, and moving your data and communication needs, among others;
- You may want to limit the possibility of this relocation to one time per lease term; and,
- Finally, you should try to negotiate a provision allowing you to terminate your lease altogether without penalty in the case that the landlord cannot meet your space relocation conditions according to the specifications laid out in your relocation language.
Alterations and Tenant Improvement Budgets.
In order to complete a build-out to fit its specific needs, almost all new leases provide a tenant with the opportunity to make physical alterations to the leased premises. One common issue that can hold up this process is when a landlord unreasonably withholds their consent to a set of tenants’ plans. While this is sometimes unavoidable, negotiating a dollar threshold limit under which landlord approval is not required, or adding qualifiers that landlord approval shall not be unreasonably withheld, conditioned, or delayed, can make a huge difference to ensure renovations stay on track. A landlord may also be willing to provide a tenant an improvement budget, or an amount per square foot that the tenant has available in landlord funding to build out the space. Negotiating a higher tenant improvement budget can go a long way to stretching critical dollars at the outset of a business establishing their new space.
Permitted/Exclusive Use; Nuisance.
Tenant and landlord should work carefully to define the parameters for how the premises will be used. A sophisticated tenant should also include language in its lease to carve out its exclusive use of the premises (including surrounding locations owned by the landlord) (as a brewery, tap house, restaurant, manufacturing, etc.). This protects a tenant’s business by preventing a landlord from leasing its nearby properties to competing businesses. Parties should also clarify the definition of a “nuisance” under their lease. Many standard definitions of nuisance include the sale of alcohol or events that might cause crowds or may say certain smells, noise, or lights are unacceptable behaviors not permitted under your lease. While these events may not come up in many commercial businesses, a wide variety of others, like breweries, distilleries, and restaurants, should be mindful they are not putting their businesses at risk of an accidental default.
Amenities.
Make sure you account for what makes your business unique. Some tenants will need more outdoor patio space or may want to promote a dog-friendly atmosphere, host live music or sporting events, or hold bingo or trivia nights. These types of events may or may not be permitted under your lease unless you negotiate them. Other items to consider, specifically for breweries or restaurants, are additional off-street parking, food truck parking (if you don’t serve food), additional outdoor storage, or the ability to access spill-over patio space into common parking lots. Coming up with and taking account of what makes your business stand out can assist in the drafting process, and avoid unnecessary conversations with your landlord.
Leasing Equipment.
When reviewing your commercial lease, be aware that the landlord might include certain lien rights as a mechanism to recoup its damages, which allows them to capture and auction a tenant’s equipment, in the event of the tenant’s non-payment of rent or other default. When leasing kitchen or brewing equipment from a third party, this provision can create conflicting lien rights between a tenant’s creditors and its landlord and may be prohibited under your equipment rental agreement. One alternative you can negotiate is for the tenant to guarantee the lease through a “guarantor,” This is typically a third party (often an individual, like the business’s owner or an interested investor) who is held financially responsible for the obligations of the tenant in the event of a default.
Early Termination.
The National Restaurant Association of the United States recognizes a 30% failure rate as the norm for new restaurants. Meaning, regardless of whether your business fails or succeeds, there is a chance you may need to leave your space before the end of its term. Tenants should make sure their lease includes the right to early terminate, sublease or assign the leased premises. There are several ways a tenant can get out of their lease before the end of the term, including:
- Mutual Agreement: The landlord and tenant can agree to terminate the lease early by signing a mutual termination agreement. This option typically requires both parties to consent to the termination and may involve negotiating any associated fees or conditions.
- Notice Period: Review your lease agreement to determine the required notice period for termination if it is available. In many cases, tenants are required to provide a written notice to the landlord within a specified timeframe, such as 60 days or 90 days in advance.
- Early Termination Clause: Some lease agreements include an early termination clause that outlines the conditions under which the lease can be ended before the agreed-upon term. This clause may require the payment of a fee or other conditions to be met.
- Subleasing or Assignment: Tenants should include in the lease the ability to find someone to take over the lease by subleasing or assigning it to another party. Subleasing involves the current tenant renting the property to someone else for a temporary period, while assignment involves transferring the lease to another individual entirely. Typically, a landlord will make this right contingent on their approval of the new party following a review of their financial statements.
- Lease Buyout: In certain cases, landlords may be open to negotiating a lease buyout, where you pay a fee or a portion of the remaining rent to terminate the lease early. This option can vary depending on the landlord’s willingness to negotiate and the terms of the original lease.
It is important to carefully review your lease agreement and consult with your landlord or a legal professional to understand the specific termination options available to you and any potential consequences or obligations involved.
Term Extension Options.
Many commercial leases include a renewal option or automatic renewal that allows tenants to continue leasing under the same or similar terms of the existing lease. Many tenants prefer this system because it grants them the power to guarantee their existing space for a longer period, and is easier than negotiating a new lease every few years. Automatic renewals or renewal options often trigger yearly rent increases at a “fair market value,” which provides some form of consistency from year to year. The challenge with the term “fair market value” is that the parties may not agree on what they consider “fair.” One alternative is to set out predetermined rent payment rates when the lease is first signed (for example, for every lease year in which the tenant occupies the premises, base rent increases by 3%). However, automatic renewals and renewal options are sometimes not to a tenant’s benefit. Tenants can miss out on potential savings and other favorable terms that can add value to the space if they decide not to negotiate their lease terms on a consistent basis. The market for commercial space is constantly in flux, and tenants may be overpaying under a renewal term than might otherwise be able to negotiate in a new lease. Furthermore, the needs of your business constantly change, so having the ability to modify the terms of your lease to mirror those needs is recommended. There are benefits and drawbacks to both options, so tenants should carefully consider what will be in their best interest.
This list of common commercial lease pitfalls is hardly exhaustive of the potential issues a tenant could face when considering their next commercial lease. If you have any questions or concerns regarding your commercial lease, you should contact a licensed professional who can guide you through the negotiation process.
About Conner: Conner is a member of the Fairfield & Woods, P.C.’s Alcoholic Beverages, Real Estate, and Real Estate Development, Zoning and Land Use practice groups. He concentrates his practice in the areas of commercial leasing, commercial real estate, real estate development, and commercial transactions, including the preparation and negotiation of all related transactional documents.
