Help with Commercial Lease Questions!

[Mike Lynch]

Hi,

We just rehabbed our first commercial property that we purchased this past summer.  ( New paint, flooring, plumbing, ) .. It has 2 very nice office units which are 1000 sq. ft. each..... Both units are empty. A Nation Wide Insurance Company wants to lease one of the units. They will have a site inspector taking photos this coming week...... Now, I am in a bit of a panic to come up with a proper lease. ..... After doing my own survey of the area, the going rate is pretty much $1.00 per foot, per month, so a 1000 sq. ft. office is $1000.00 per month.

The building is in Brunswick Co. NC. .... I need to install a rent rate increase into the lease agreement...... How much percentage should I add per year? ( 3% --- 5% / other?

How many years should I lease or not lease / timewise? ..... I mean, what if they say 5 years or 10 years?

I am thinking about doing a Modified Gross Lease.

( Tenant pays: ..  Rent, Utilities, Janitorial, Interior Maintenance )

( Landlord Pays: ..  Property Taxes, Insurance, Common Area Maintenance )

If I am wrong about anything, please let me know, as I am brand new and wet behind the ears....... This Nation Wide Company, I'm sure, is used to doing a lot of leases every year..... They are pros, and I am not...... I am worried that they may get the best of us, if I am not careful.

Any advise to help me lease to a professional that knows all of the tricks would be great!

Thanks! :)

Mike 

[Steve McGovern]

Hi @Mike Lynch-- Congrats! 

First, tell me what type of property this is-- is it just a stand alone downtown building? Party walls?  Is it in or very close to a well-traveled retail district?   these all affect your ablity to lease and/or to tailor your replies.  

Second-- NOT to be snooty (I promise), but so you have the value of sounding like you belong when working around the Real Estate teams of your tenant:  a commercial rental rate is an annual rate.  Instead of "one dollar per foor per month," We say,  $12 psf  or "Twelve bucks a foot" when spoken.  It's lingo, but it's established lingo, so if you say "a dollar a foot," and forget the month part, you've just reduced your value by 92%. 

-- Is the area already up & coming?  Could you command $12.50 or $13?   

-- Does this money give you enough to run the entire building at a profit, or do you NEED a second tenant?  I'm only thinking of your flexibility here, to hold out for the right tenant next time, or your need to shove a loud gym next to them if offered... which won't make the insurance company too happy.  Look up legal tenets of  "Quiet enjoyment"   Appropriate tenant mix is a real thing to consider.  

Now, yes, commercial leases are generally for 5 year terms with (x) number of additional 5-year options.  That helps you by giving your books a stable tenant.  Your Lenders and your future tenants in the other unit will both appreciate a long term lease/neighbor from a national, reputable, stable company.  get them on the hook as long as you can.   Here's where it gets tricky: 

1) Your Escalator should be 2-4% per year;  they'll try to get you to say 10-15% per TERM.  Keep in mind your high school accounting class: you want your escalator to be ANNUAL because 2& compounded over 5 years is NOT 10%, it's 10.4%.  Additionally, who says they'll renew in 5 years? You want your compounding now. I'd aim for 3%, but I'd also take a little less in % to make sure they pay you in an annual escalator.  

-- Percentages are just decimals. if you can't agree between 3 & 3.5% don't be afraid to aim for 3%1/3, 3&1/4, etc. Their books will be used to handling this.   

2) in that term, they'll try to negotiate an automatic option; you want them to be held to give you a notice within a REASONABLE amount of time-- how long do you think it'll take you to find another tenant in 5 years?  Again, we have no forward knowledge of macroeconomic events, but you know if your area is growing or shrinking.  Negotiate a notice period of at least 180 days, prior to end of term;  they'll try to work you down to 90, don't be surprised. if the words, "I can't find a new tenant in three months" jump into your head, then stand firm on 6 months.   

3) in terms of your OpEx, the things you listed should already be attributed to them, generally speaking.  However I would also charge a rate psf back to them that reflects the Insurance, Taxes, and exterior maintenance to them.  You NEED to research NNN Leases, and you need to have an appx. number in mind.  Everything from landscaping to furnaces blowing to downspout fixing should be part of this:  this is NOT a Condo, and it's not a residential lease.  here are my two opposing thoughts on the matter:  

A) Don't let them take advantage of you; 

b) If you're happy paying taxes AND/OR that's the norm in your area then, well, who cares? have at it.   It's better than losing a good tenant.   (but I doubt it-- not for a n ational insurance co tenant!) Either way, any broker or savvy tenant will expect you to have this nailed down before you speak to them, so definitely jump on the case here.  

Other matters-- You may be met with concerns of ROFR or having a certain net worth or a certain Insurance amount. They may demand that you keep the exterior up to THEIR corporate standards; I'd negotiate back to them that if their corporate standards require (x) then it's their responsibility to do that for the building.  Then find the middle ground between the points.   

ALL Of the above plus... Indemnification, subrogation. your ablility to finance/refinance the property all come into play in a commercial lease, and one wrong article ("And" instead of "or") can literally mess you up here.  These are times when you need a GOOD Commercial Attorney to look at for you to make sure you are not already in default of a non-monetary term.   I know a great one in NC who is reasonably priced-- if you need one, PM me.  

Generally, a commercial Broker should also be able to help you through some of the primary pieces of this.  

You have a lot to think about here.  I hope that helps you for a start.