Leasing Fundamentals

In these pages I will share basic methods and key points related to aspects of commercial real estate (CRE).

Leasing Fundamentals:

The leasing of commercial space can be both daunting to consider and complex to navigate. I highly recommend seeking out an experienced broker to assist you. Even if you have to pay their fee yourself – much like a lawyer – you should find yourself much better off. There are too many complex concepts and dark alleys where you can find yourself responsible for expenses.

Caveat out of the way the more you know and understand of the process the better you be able to find your way successfully through the leasing process.

I will begin with a simplistic example of the leasing process and then add layers to it, address some of the complexities to be aware of and discuss a few strategies to consider. For the sake of brevity I will be considering the process from the perspective of the tenant. If there is demand in the future I can revisit this and consider it from the landlords perspective.

So you have a business and you need to lease some space. Here is the basic outline of the process:

  1. Evaluate leasing requirements: type of space; size; location; budget; timing.
  2. Review all available spaces that meet requirements
  3. Pick your top 3 – 5 options and tour them
  4. Pick the best fit and begin negotiation
  5. Finalize negotiations
  6. Execute lease; deposit, etc.
  7. Complete tenant improvement (TI) & Move into the space
  8. Open for business

Depending on on the complexity of your spacial requirements and financial constraints this process can be completed in as little as a month or as much as a year or more.

Do yourself a favor and throughout the process do your best to focus on the requirements and finding the space that meets those requirements. History is littered with businesses that have moved into a space that was aesthetically appealing but a poor fit for the actual business.

Now let’s unpack each of the points in the process just a little to shed some more light on the leasing process.

Leasing Requirements

The first step in the leasing process should be a complete evaluation of the business requirements for the space to be leased. This includes any aesthetic needs. If you’re an interior decorator your requirements will be substantively different from a hatchet throwing bar. The following key points should be evaluated in determining your requirements:

  1. Space size requirements
  2. Aesthetic requirements
  3. Locational requirements (demographic, traffic, etc)
  4. Business specific needs (power; water; parking; etc.)
  5. Future expansion / contraction

I would encourage you to start with a very wide set of requirements as you begin your search and as you review properties refine the requirements. For example if you think you’re going to need ~2000 square feet (sf) of nice office space start your search looking at everything up to and even above ~5000sf and including other building types. Depending on pricing and other factors retro fitting an older retail space could be cost effective and provide a benefit.

The above does assume that you have complete latitude to select your space. If you have a franchise or are part of a corporate entity there will likely be requirements that you will need to work within. Get these out in the open early so you can work within them to find the best space. Tell your broker day one if you have hard limitations.

Available Spaces

Once you have communicated your requirements to your broker and they have had a chance to search and provide you the details on all the options available it’s time to evaluate each of the spaces.

Typically you will receive a breakdown of each space detailing the size, location, type, and notable details. If your broker does not include an overview map of all the options you should absolutely make one. It is critical to consider your location choice from many angles and seeing the 10,000 foot view can be invaluable in understanding potential spaces.

For example if you are looking to open a cafe and as you look at an aerial map of all the available options you can see quickly that one of the locations is adjacent to a national grocery store that can be invaluable in valuing the option.

With luck you will be reviewing a dozen or more potential spaces initially. Your goal in this phase is to narrow down the options to three or four that appear to meet the majority of your requirements. I recommend reviewing the options multiple different times from alternate perspectives. Review the list once from the perspective of which is the best physical location then return and review the list for which is the most aesthetic, then again from a pricing perspective.

This process will allow you to grade each of the options and bring to the top the best options that actually fulfill all of your requirements.

It is rare that you will find exactly the space you are looking for. Typically you are going to get most of what you want but not all, so consider all the requirements you are willing to be flexible on. If an option is the dream location and already built out are you willing to pay a premium for it?

Once you have whittled the list down to the top three or four options it’s time to visit each of them and look closely to see how things might work.

The Tours

Don’t be shy about taking your time as you walk through each space. Make notes on things you see. Note any issues. get a feel for the space and how you might operate within it. This can be harder to do when it either is already built out in a way you wouldn’t want it or it’s not built out at all. it can be hard to visualize a wide open space and how it might break up best.

There are professional interior designers who specialize in commercial interior layout and even some architects have experience in doing this. Depending on your budget, space and goals this can be an expense well worth budgeting for. A 20,000sf wide open space can be overwhelming when you get into the details (where do you put the outlets?). Get help.

Also when you’re on the tours take pictures and video. These will be invaluable for sharing with others who may not be able to join you on the tour.

At a minimum I would expect to spend between 15 – 30 min on a 5000 sf space, regardless of type. There’s a lot to look at and understand. Do not be rushed and if you need more time set up additional tours.

Once you have been through all the potential spaces get all your info put together and evaluate the options in detail. List pros and cons and begin weeding out those that have issues. Get down to two options, then one.

Negotiation

Prior to initiating negotiation you will want to evaluate your budgetary constraints and determine the range of pricing that will be acceptable. It is critical that you completely evaluate and establish your ceiling on pricing prior to negotiation.

Consider not just the base rate as noted in the details on the space but also the expenses. Make sure you understand and are clear on all items you are financially responsible for throughout the term of your lease and that you are including them in your budgetary calculation. Everything from electricity to garbage collection to after hours HVAC expenses. Keep in mind that if the landlord is providing you something they have usually found a way to charge you for it. So, any benefit or amenity should be scrutinized closely. Nothing is free and nothing is given away.

This is also the time to fully engage with a real estate attorney. Not a general law lawyer, you want someone focused on real estate. This is critical. There are many unique details in real estate transactions that can cause other lawyers to balk or even miss because they do not understand the conventions. The legal issues with leasing can and do expand to fill entire books. Get a good lawyer and listen to them.

Once you have a workable financial range and everything ready to go it’s time to make your initial written offer to the landlord. Your broker will help to determine where your initial offer needs to be based upon their understanding of the market and the landlord. As I noted before do not be rushed through this phase. Make an offer you can get behind 100%. If that doesn’t even solicit a response move on. You can beat yourself to death and get in way over your head quickly in lease negotiations. When in doubt slow down.

Your offer should include planning for lease renewals (options) and expansion options. Both of these need to be evaluated based upon your business projections. Discuss these with your broker and make sure you are planning for the upside as much as you are for the down. If your business is cranking and growing at the end of your initial lease term you want the option to renew your lease or even expand your space. Both can be negotiated to provide you with that potential prior to signing the initial term. Make sure you have considered this and included in your proposal.

Do not be surprised if offers and counter offers go back and forth numerous times. This is why it is critical to understand your baseline terms and pricing. A savvy landlord is going to negotiate nearly everything to their benefit and you need to be ready to evaluate where you are willing to give them the upper hand.

Again this is an area where there are entire books on how to negotiate a lease and things to be aware of. This is also where your broker will show their experience and ability. Finding a property is relatively easy but negotiating the nitty gritty on a lease takes a deft touch.

I have seen getting to agreement take as little as two hours and as long as a year all depending on the flexibility of the participants and their sophistication. Always remember that the landlord is negotiating for themselves and their benefit. No matter how nice they are they make money owning the property so this is where they are setting their income and they’re going to want the best deal they can get. Seems obvious but I’ve seen many tenants lulled into accepting a bad deal by a sweet talking landlord.

Do not sign anything before you have your attorney review and sign off on the entire lease. Also take the time to understand everything in it. If you don’t know what an estoppel is get your attorney or broker to explain it and the ramification of it. That is just one example make sure you are comfortable with all the terms.

The vast majority of leases will require a personal guarantee. The only exceptions I see are larger corporate entities that then bind the corporation directly to the lease. Get comfortable with the idea that you are going to be personally liable for the full amount of the lease. The personal guarantee allows for the landlord to recoup, from you personally, any unpaid rent. Get your lawyer to lay out exactly how this works. You will want to be well aware of this if the bottom drops out and you’re left holding the balance due.

There are ways to limit your exposure in the guarantee and your broker and lawyer should be able to assist in laying those out for you. Again this can be a point of negotiation all by itself during lease negotiations.

Lease Execution

Once you have reached an agreement on all points in the lease it’s time to execute and begin your lease. A couple items to keep in mind prior to execution: always review the final copy of the lease presented by the landlord against the last agreed upon version before you sign to verify that no other terms have been changed.

For lease execution there is not always a meeting of the landlord and tenant. Many times the landlord will simply send you the final lease and you will execute and return with a deposit check. This can feel a bit anticlimactic but it allows you the unpressured time to fully review the final lease and ensure you have all the pieces in place and ready to go.

Once the lease is executed the clock starts. So, take the time to double check that your contractors are lined up for any and all tenant improvements; that any supplies or required materials are ready to go so that you can minimize downtime before you open your space for business.

Typically there will be a requirement of a month or more of rent to be submitted at lease execution as deposit. For most leases this deposit works much as a deposit on an apartment. You’re puttin up money to give the landlord assurance you are not going to trash the place and leave. Make sure you have a check ready to go before signing.

Once you have executed the lease and received the keys and go ahead to access the space it’s time to get everything set up for you to open your business.

Tenant Improvement and Move In

If you have planned well the minute you have executed the lease you will be able to get to work modifying the space to meet your specific requirements. Depending on needed modifications this can take weeks or months to complete and depending upon the negotiated terms during this period you may have to be paying the entire lease and all expenses even though you’re not even occupying the space. Be ready for that, not just financially but psychologically. It can be very stressful, especially if there are issues in the build out and it takes two months longer than anticipated to complete your buildout.

I highly recommend working closely with your contractors and being on site as much as possible during the buildout. It will allow you to make quick decisions on issues that arise and be aware of progress and abe to adjust all the other moving pieces, like moving.

Moving can be an enormous project in and of itself depending on the size and scope of your operations. If you are just opening up a new shop this is not an issue but if you have multiple office locations scattered around a city and are consolidating them into one location this can prove an enormous juggling challenge. I highly recommend in complicated situations the retention of a professional moving service with experience in moving businesses. Their experience will prove invaluable and smooth out many little things that always come up.

Open for Business

Once everything has been finished and all equipment has been moved in it’s time for you to get down to actually doing your business! I do recommend giving yourself at least a week and even two before you formally have a ‘grand opening’ event. There are always last minute things to take care of and it’s beneficial to have a couple days to get your bearings in the new space before being fully open. Again much of this timing will depend on your business requirements.