How to negotiate a commercial lease effectively
7-minute read
Rent can be one of your biggest business expenses. However, many entrepreneurs do a poor job of negotiating their commercial real estate lease and wind up stuck with major hidden costs. If you’re not careful, that could have serious repercussions for your company’s profitability.
“It’s surprising how many businesses sign a lease without reviewing it,” says BDC Business Centre Manager Brett Prikker, who has financed numerous commercial real estate transactions.
“They just sign whatever they’re given by the landlord, but leases are typically open to negotiation,” he says.
Even worse, many businesses do without a lease altogether, renting their space on a monthly basis. If you do that, you could be kicked out with little notice and lose the value of any renovations you’ve made. Without a lease, you may also have a hard time getting bank financing for your business.
“At a bare minimum, you need a lease to protect your business and to ensure you get value out of any improvements you make,” Prikker says.
These tips from Prikker will help you negotiate an effective commercial lease—one that protects your needs and works to your business’s best advantage.
1. Evaluate your business needs
Do a little homework before negotiating a lease. List your company’s current and expected future space needs, and determine your budget and preferred location.
“Ask yourself what you want to get out of moving,” Prikker says. “You can then negotiate a lease that covers everything off.”
If you’re uncertain about near-term needs, consider a shorter lease (for example, two or three years). “You may pay more per square foot for a shorter lease, but at least you can walk away more easily if you need to,” Prikker says.
2. Always involve a lawyer
It’s critical to involve a commercial lawyer in your lease negotiations. “Always, always, always get a lawyer’s opinion,” says Prikker. “It’s best to get a good commercial lawyer who understands leases. Some businesses use a general or family lawyer, and then end up signing a lease with unexpected costs. Leases are complex, and I’ve seen a lot of mistakes made.”
3. Understand your costs
Carefully review the incidentals you are being asked to pay for to make sure the total cost fits your budget. Any future increases in base rent and incidentals should also be clearly specified. Don’t be shy about asking for changes.
4. Understand your lease options
The costs covered in the lease can vary greatly, based on the type of lease.
- In a gross rent lease, you pay a single amount to the landlord that covers base rent and all incidentals. Those typically include utilities, property tax, insurance, maintenance, repairs and common area expenses, such as snow removal, janitorial services, landscaping, grass cutting and property management. Another option is a modified gross lease, in which you and the landlord share some combination of incidental costs.
- It’s also possible to sign various kinds of net leases, under which you pay some incidentals directly. This usually results in a lower rent. The main differences between net leases are as follows.
- In a net lease, you usually pay for the base rent plus one of the following: property taxes (most common), insurance or utilities. Your landlord pays for all other expenses.
- In a double net lease, you pay base rent plus property taxes and insurance.
- In a triple net lease, you usually pay base rent, plus property taxes, building insurance and utilities, as well as other operating and maintenance costs.
Note: While the above definitions are standard, landlords sometimes add maintenance or common area expenses to your costs as part of a single or double net lease, so always double check what you must pay for.
- In a percentage rent lease, you pay a base rent plus a percentage of your gross sales over a certain minimum. These are usually used in malls and other multi-tenant retail locations.
5. Check market rents
Get an idea of market rents in the neighbourhood you’re considering and compare them with the landlord’s asking rent. Talk to a commercial realtor to get up-to-date market lease rates. This information can help you negotiate a lower rent if the asking figure is high.
6. Research the property
Gather information about the property that might come in handy for your lease negotiations.
- Look at the building’s tenant mix and neighbours to make sure they’re compatible with your business. Are there any competitors?
- Find out what the building’s traffic is like. If other tenants use most of the parking spaces, will you have enough for your needs? You may be able to negotiate lower common area payments if other tenants have much more traffic than you do and use the building more.
- Talk to other local businesses to find out about the neighbourhood and any issues that could affect your company. For example, if you’re a retail business, you may want to know about local foot traffic, and whether the neighbourhood is growing or in decline. Recent declines in a neighbourhood’s prospects or market rents could help you bargain for more favourable lease terms.
- Look into the landlord’s reputation to see whether there are any red flags. You can ask realtors or existing tenants. For example, you may find other tenants are trying to get out of the building because of difficulties with the landlord.
7. Seek tenant inducements
Ask the landlord for inducements to rent the space. The landlord may be especially eager to entice you to rent—for example, if the space has been vacant for a while. It’s common for landlords to offer two or three months rent free. Some may even pay for part of your renovations or finance them over the lease duration.
“You should always ask what inducements they can provide,” says Prikker. “You’d be surprised what you may get offered.”
8. Review termination conditions
Check the circumstances under which either party may terminate the lease. For example, can you be kicked out simply for missing a rent payment? What happens if the building is sold?
If your sales decline or you want to expand to a bigger space, how can you break the lease? Some leases require you to pay all or part of the remainder of the rent. You can negotiate for better terms.
Also, look at whether you can sublease the space. If sales decline, subleasing the whole space could allow you to move elsewhere without paying a hefty lease termination penalty. Alternatively, you could sublease part of the space to help cover the rent.
9. Negotiate leasehold improvements
Businesses often need to renovate a new space to suit their needs. You should make sure the lease and zoning allow your planned leasehold improvements. As well, you can seek a clause requiring the landlord to reimburse some or all of your leasehold improvement costs if the landlord breaks the lease.
10. Check for a competitor clause
You can ask for a competitor clause in the lease that requires the landlord to get your consent to rent space in the building to a competitor. This may be particularly important to retailers.
11. Look at renewal conditions
The duration of your commercial property lease can range from month-to-month to several years. Be sure to understand when and how the lease will be renewed. Also ensure that you have the option to renew the lease at the end of the term, if that is important to you. You may be able to negotiate other options, such as the right of first refusal to lease an adjoining unit for expansion. Alternatively—if the rental market has declined, for example—the landlord might give you a better deal when you renew.
12. Don’t be quick to sign
Landlords typically submit their own lease to prospective tenants. It’s vital to carefully review this document and the proposed responsibilities of the tenant and landlord.
“I’ve seen leases where the tenant didn’t do their homework and ended up being responsible for all sorts of unexpected costs or couldn’t break the lease without paying the remaining rent in full,” says Prikker. The proposed lease usually isn’t fixed in stone. “There’s typically negotiating room.”