Commercial Leases: Negotiate the Best Terms

When you get serious about an available business space, chances are you'll be presented with a typed or printed commercial lease prepared by the landlord or the landlord's lawyer. As you read the lease, keep these points in mind:

• Rule 1: The terms almost always favor the landlord.
• Rule 2: With a little effort you can almost always negotiate significant improvements to the terms.

In theory, all terms of a lease are negotiable. But your negotiating power depends on whether your local rental market is hot or cold. If plenty of commercial space is available, you can probably win many landlord concessions. If your area's rental market is tight or you're chasing a unique space, you'll have considerably less leverage.

Types of Leases: Gross vs. Net Leases

Your landlord will likely present you with one of two types of common commercial leases:

• a gross commercial lease, or
• a commercial net lease.

In a gross commercial lease, you'll pay one flat monthly fee that includes your rent and operating expenses. In a net lease, you'll pay a fee for rent and a separate fee for your share of the operating expenses. Your share of the operating expenses depends on the type of net lease you have—single, double, or triple:

• In a single net lease, you pay the property taxes.
• In a double net lease, you pay the property taxes and property insurance.
• In a triple net lease, you pay the property taxes, insurance, and maintenance costs.

How you negotiate the terms of your lease will primarily depend on the type of lease you have. Each type of lease requires specific conversations between you and the landlord.

Negotiating Specific Lease Terms

As you review your lease, regardless of what kind of lease it is, you'll need to pay close attention to the specific terms of the lease. Some terms will be dealbreakers while others might be good points of leverage. For example, suppose you're flexible on the length of your lease but you want to make sure the lease allows you to sublet your space. In that case, you might concede a longer lease term, which the landlord would prefer, in exchange for an unrestrictive assignment and sublease clause.

Let's discuss the primary negotiating points in a lease.

Length of the Lease

One area of the lease you should always focus on is its length—also, a little confusingly, called its "term." When looking at the lease term, consider:

• the actual length of the lease, and
• whether there's an option to renew or extend the lease.

Short-Term vs. Long-Term Leases

A short-term lease is almost always to your benefit. Shorter leases give you more flexibility if the needs of your business change—for example, you want more space or decide that a different location would be better. There's a trade-off here, of course. A long-term lease ensures that you'll have an affordable business space for a predictable period of time. And landlords are often willing to make more concessions on longer-term leases.

If your business isn't particularly location-sensitive (a primarily online business, for example) and plenty of commercial space is available in your area, then a short-term lease makes sense. Even if the landlord doesn't renew your lease, finding a comparable space won't be a problem.

On the other hand, if you have found an especially favorable location for a retail shop, restaurant, or other business where location is key, deciding on the best lease term is more complicated. If your business does well, you'll want the right to stay on for an extended period. On the other hand, you'll probably be nervous about signing a four-year lease in case your business closes.

Option to Renew or Extend Your Lease

When you've secured a desirable commercial location, you'll want to make sure you secure the location for the long term while also building in protections for yourself in case you need to cut your lease short.

A good solution is to bargain for a short initial lease with one or more options to renew—perhaps a one- or two-year lease with an option to renew for two or three more years. Typically, an option to renew gives you the right to exercise your option to stay by notifying your landlord in writing a certain number of days or months before the initial lease period expires.

If you ask for an option, expect the landlord to want a higher rent for the renewal period. If the property is particularly desirable, the owner could also want an extra fee in exchange for giving you the option of staying or leaving after your initial term is up. An option is a common arrangement, and if the space is important to the success of your business, seriously consider paying for it.

Rent and Rent Increases

Another primary issue to consider when leasing space is how much rent you'll pay. The rent typically differs drastically between gross commercial leases and net leases.

Rent for gross commercial leases. Typically, rent in gross commercial leases is higher than for net leases. The rent is higher because landlords generally factor in other costs to come up with the flat rate they present to tenants.

Rent for commercial net leases. You'll likely see lower, more attractive rent prices in a commercial net lease. However, you'll end up paying for other operating expenses separately—potentially a large sum. In fact, the best approach might be to offer to pay a higher amount for rent in exchange for eliminating these extras. When negotiating these costs, you'll need to consider your share of the expenses versus the landlord's and the other tenants'. Figure out what your fair share of these costs are, how much these expenses will increase as time goes on, and how the total cost compares to the rent in a gross lease.

It's sensible to check out rates for comparable spaces. If the rent seems unjustifiably high, try asking for a reduction. Many landlords, however, usually won't consider lowering the rent (except in poor economic times or areas). But you might be able to get a few months of reduced rent to compensate for moving costs.

Landlords usually include an annual increase to your rent in your lease terms. If the landlord insists on keeping the clause, try to get a cap on the amount of each year's increase, and try to exclude a rent increase for the first year.

In some cases, landlords will charge rent based on a percentage of a business's profits. A percentage rent isn't very common and usually only applies to retail spaces with high gross sales—think, malls, for example.

Tenant Improvements

If you need to make improvements to the space, you might want to use the lion's share of your bargaining power to have the landlord provide them at no cost to you. If you're willing to sign a long-term lease, the landlord will be more willing to pay for improvements to the property.

You have some options when it comes to negotiating improvements. Consider pushing for a tenant improvement allowance (TIA). A TIA is an amount the landlord will pay toward the costs of improving a commercial space. If the landlord is open to writing a TIA into the lease agreement, you'll need to negotiate how much the TIA will be, what kind of improvements you can make under the allowance, and who'll do the work.

You should also clarify in the lease who pays for improvements throughout the life of your lease. Keep in mind that repairs and maintenance are different from improvements. If one of the doors doesn't close as it should and you spend money to fix it, that's a repair, not an improvement. Typically, landlords should pay for repairs and the tenant will pay for any improvements. You should specify which improvements require landlord approval beforehand in the lease's Improvements and Alterations clause.

To learn more about improving your space, including who does the work and who should pay for it, read our article about improvements for your commercial space.

Subleases and Assignments

Ask for the right to sublease or assign your space. That way, if you need to move out, you'll be able to have another tenant take your space and pay the rent, without having to break the lease. Or, if you rent enough space to grow into, you can sublease some of the space until you're ready to use it.

Using Your Commercial Space

Often overlooked, the use and exclusive use clauses can be critical to your business's operations. A use clause dictates how you can or must use your commercial space. An exclusive clause dictates who else the landlord can rent to (for example, what other kinds of businesses can occupy the same strip mall).

If your lease includes a use clause, make sure it doesn't restrict your ability to make a profit. Some restrictive uses are understandable. But if a use clause makes your business impracticable or presents too much of a burden, the space might not be worth it under those terms. Strongly consider negotiating a more favorable use clause or striking it out of the lease completely.

On the other hand, an exclusive clause can give you an advantage by keeping out competitors. For instance, if you run a used bookstore, you can benefit from an exclusive clause that prevents the landlord from signing a lease with another bookstore tenant.

Eight Tips for Negotiating Your Commercial Lease

Negotiating a commercial lease can be tricky. Be prepared before the negotiations begin. Know your options as you go back and forth with your landlord. Follow these tips to negotiate the best terms for your commercial lease.

1. Figure Out Your Business Needs vs. Wants

Chances are you've thought about the different things that would make your business perfect. If you're a clothing store, maybe it's a prime downtown location, with a large stockroom, large show windows, and ample floor space for customers to shop. Maybe your business needs downtown foot traffic to turn a good profit but it doesn't need that corner lot. In that circumstance, your need would be a downtown location but your want would be a corner spot.

Or suppose you want to open a restaurant and you'd like to have a large deck to house outdoor seating. You might need space for your customers to sit but it might not need ample outdoor seating. In this case, outdoor seating is a want and probably not necessary for your business's success.

Separate your business needs from your business wants. Use this analysis to determine which terms are:

• critical (a must or need)
• negotiable (a preference or want), and
• immaterial (and you can potentially leverage).

Once you figure out which features are a dealbreaker and which you can live without, you'll be in a better position to not only look for properties but to negotiate the best teams for your lease.

2. Develop a Budget and Maximum Price

You should run your numbers before you start seriously looking at commercial locations to know what you can afford. Look at your past financial figures to figure out your budget. You can prepare a profit and loss forecast or cash flow statement and try various rent costs. On the highest end of your budget should be the absolute, all-in maximum you can reasonably afford and still make your desired profit.

When you start your search, make sure you know what a place's rent equates to. Is the rent for a gross lease or a net lease? Does the rent include utilities? A place that seems affordable at first glance could actually be above your budget. If you find the perfect place but it's above your budget, you might be able to negotiate a lower rent, particularly if it's a buyer's market.

3. Research the Geographic Area

As you look at where to open your business, you'll have two main considerations:

1. the cost, and
2. the potential profit.

First, make sure you can afford to rent in the area. If you're a new business that depends on low costs, you might not be able to afford to lease a space downtown beside a designer brand store. You could need to expand your search to just outside of the downtown area to more affordable, but still desirable locations.

Second, you'll need to consider the potential profit of a geographic area. Is your business on a major road with high visibility? Is your business easy to find and close to town? Does your business depend highly on foot traffic and passersby? What your business needs and gets out of a location can determine how much you're willing to invest.

4. Consider the Turnover in the Area

A high turnover of tenants can be a red flag. If you've noticed that three different businesses have occupied a spot in just five years, the rent might be too high or the area might not see enough customers. Or, the landlord might be difficult to work with. In all likelihood, there's a reason for the turnover. You should do a little digging if you're serious about the property.

5. Get an Idea of All Costs Associated With a Property

When you start your search, make sure you know what a place's rent equates to. Is the rent for a gross lease or a net lease? Does the rent include utilities? A place that seems affordable at first glance could actually be above your budget. If you find the perfect place but it's above your budget, you might be able to negotiate a lower rent, particularly if it's a buyer's market.

6. Check Out Comparable Properties

If you find a commercial property you're interested in, confirm that the proposed rent is a fair price. Look at the rent for other comparable properties. These properties should be relatively comparable in terms of location, square footage, and the state of the space itself. If you find that comparable properties are charging a lower rent, then you can use these comps in your negotiations.

7. Visit the Proposed Property in Person

If you plan to invest a large chunk of your funds into rent, it's best to visit the property in person. Pictures in a listing can be misleading or not give you the full picture. If you walk around the property first, you might notice things you didn't think about before like lighting or the number of outlets. You can also take the opportunity to check out your potential neighbors, ease of access, and the surrounding area.

8. Understand your Bargaining Power

Before you enter into negotiations, know your bargaining power. Ask yourself these questions:

• Is it a landlord's market or a tenant's market?
• What do comparable properties offer and at what cost?
• How long has the property been vacant? (If the landlord hasn't had a tenant in a while, they'll likely be more willing to give in to your demands.)
• How committed are you to the property? (If you'd be fine with signing on another property, you might be less willing to sacrifice on this lease.)

Your bargaining power will determine how good of a deal you get. Consider hiring a lawyer to review or negotiate your lease for some additional expertise. A commercial lease attorney can do some of the heavy lifting for you and leverage your bargaining power to get the most out of your lease.

Additional Information About Commercial Leases

For a checklist of critical lease terms to watch out for, see our article about what you should know about the commercial lease. If this isn't your first commercial lease or you're familiar with commercial leases in general, you can negotiate the terms yourself. But if you want a second pair of eyes or the landlord won't budget on some terms, consider finding a commercial lease attorney to review or negotiate your lease.