Lease Terms You Need to Know
If you're looking to lease new office space, it's crucial to understand the terms and provisions of the contract you'll be signing. This guide will explain the essential lease terms you need to be aware of in your search.
Letter of Intent (LOI)
The LOI should outline the "heads of agreement" for which the lease document will be based. Don't issue an LOI unless it is your intent to follow through in good faith. Beware of written business-based side agreements which could become legally enforceable "letter agreements." Make sure to have an attorney review any letter of intent or term sheet before submitting to the negotiating party. Also, different states have differing laws relating to the legally binding nature of things like the LOI in real-estate deals. Do your research and consult an attorney.
Tenant Improvements
Tenants should seek out space that requires minimal improvement wherever possible, especially in booming markets where construction costs are rising quickly and contractors are backlogged. If considering shell space, ensure that you truly understand how your organization operates before opting for a (supposedly) less expensive "open plan" space design. Trendy open plans and exposed ceiling space can cost more than traditional drop-ceiling offices, and does not necessarily work for team members whose work requires unbroken concentration (i.e. programming).
Tenant Improvement Allowance
When negotiating a lease, it's essential to understand the tenant improvement allowance (TIA) and what it covers. Is this provided above a "warm shell"? Specifically, are ceiling grid and tiles, lights and base HVAC part of the base package? While it is unusual in today's landlords' market to get a turnkey deal (built out by landlord to your specifications), it is always worth asking for this. A landlord might agree to it for a strong-credit tenant on a long-term lease, as long as the buildout is not overly specialized. When working on an allowance, we usually advise clients leasing more than 10,000 square feet to hire their own construction project manager.
Common Area Maintenance (CAM) Charges
These are passed on directly to tenants in triple net (NNN) leases to cover the maintenance of buildings and their grounds. Ensure that your lease is explicit as to the common area maintenance charges included—and that you only pay for services actually delivered or maintenance actually done. Always request a breakdown of previous years' actual expenses so you are not blindsided by unforeseen charges.
Capital Improvements
Landlords have the right to pass the amortized cost (over its useful life) of replacement and repair of building components such as roofs and HVAC onto tenants. Be sure to ask the landlord if any such items are at or near the end of their natural lives, and if so, try and exempt such deferred maintenance costs from your lease for a reasonable period.
Base Year
In a full service or gross lease, landlords have the right to pass through increases in actual operating costs over and above those included in the first full year of tenancy. This is in addition to any annual increases in base rent. Which is why steps four and five above are so important. If the base year estimates are too low, you could be in for a significant and unanticipated increase in lease costs upon the second year of your lease.
Actionable Steps for Investors
- Familiarize yourself with all lease terms discussed in this article before entering negotiations.
- Always consult with a real estate attorney to review the Letter of Intent (LOI) and final lease agreement.
- Carefully evaluate your space needs and consider the long-term costs of tenant improvements.
- Request a detailed breakdown of Common Area Maintenance (CAM) charges and historical expenses.
- Inquire about upcoming capital improvements and negotiate to exclude costs for deferred maintenance.
- Pay close attention to the base year in full service or gross leases to avoid unexpected cost increases.
- Consider hiring a construction project manager for larger spaces (over 10,000 square feet) when working with a tenant improvement allowance.
Now that you're equipped with this knowledge, take the next step in your commercial real estate search. Browse available commercial real estate for lease to find the perfect space for your business. Remember, understanding these lease terms will help you make informed decisions and protect your investment in the long run.
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About the Author: Paul Suzman
Paul Suzman is the founder of Seattle-based OfficeLease, which was established in 1981 as the first commercial tenant/buyer representation firm on the West Coast. He has negotiated hundreds of leases for over 6 million square feet of office space and counts among his current clients three publicly traded entities.
This article was updated on 10/10/2024
