As major corporations like JPMorgan, Amazon, and AT&T recently mandated their employees to return to the office five days a week [1], you may be thinking about your company’s future and whether it’s appropriate to lease new space or renew your existing lease. Given the current commercial real estate market is favorable to tenants, there are key points to consider before entering lease negotiations that will strengthen your position and ensure your lease meets your financial and operational needs.
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First, review the market to understand current rental rates. Tenants can offer below-market rent or smaller annual increases (2% vs. 3-4%), abated rent for the first handful of months, and tenant improvement allowance (known as “TI Allowance” or “TI”) for upgrades to the premises which could consist of new carpet, fresh paint, or HVAC upgrades, with the cost amortized over the term of the lease. All commercial tenants—especially Arizona tenants—should consider negotiating maintenance and repair obligations for HVAC issues given the oppressive summer heat, as well as roof, and structural repairs. (This is very important if the existing HVAC units are near the end of their useful life, in which case, they require inordinate repair and maintenance.) Tenants should also push for clearly identifying the criteria for a “replacement” vs. “repair” (which are typically “landlord” vs. “tenant” obligations, respectively) of the HVAC to mitigate financial risk, and rent abatement for days when the HVAC system fails to perform. An objective “standard” for performance would also avoid disputes as to whether the HVAC system is performing.
Second, consider whether you anticipate your team to grow, downsize, or adopt a hybrid schedule over the time period of the lease agreement. If you’re unsure, it’s important to maintain flexibility with lease provisions that grant you early termination rights, and right of first offer (“ROFO”) or refusal (“ROFR”) on adjacent space.
Third, evaluate the cost of paying your proportionate share of taxes, insurance, and operating and maintenance expenses. In addition to paying rent, those expenses are hallmarks of a “triple net” lease. To safeguard against significant increases in those charges, negotiate caps on controllable expenses and request detailed annual reconciliation statements.
Fourth, confirm the occupancy percentage of the building and whether the landlord requested a “gross-up” provision be added to the lease. A gross-up provision allows the landlord to adjust operating expenses to reflect what they would have been if the building were fully occupied, even when it’s not. For example, if a building is only partially occupied, operating expenses (such as trash removal, janitorial, utilities, etc.) are low for a tenant. Consequently, landlords would be responsible for high variable costs until the building’s occupancy level increases. As such, a landlord may propose a 95% gross-up provision, where expenses are adjusted to reflect the tenant’s expenses if the building is 95% occupied. While this provision generally favors landlords, it can protect tenants from significant spikes in expenses when the building occupancy eventually increases.
Fifth, a commercial real estate attorney can be an invaluable partner when negotiating complex leases, including those for multi-use needs, industrial uses, telecom infrastructure, distressed properties, lease-to-purchase deals, and uses involving environmental purposes such as solar-generation. Consulting with an experienced attorney can ensure your business takes advantage of all possible opportunities and incentives to maximize financial resources.
Lastly, remember that everything is negotiable, especially in the current commercial real estate climate. Please feel free to reach out if you would like to discuss preparing for your next lease.
Author: Joseph Perotti, of counsel at Gallagher & Kennedy, counsels landlords and tenants in commercial real estate lease negotiations, lending and financing, purchase and sale transactions, and zoning and land-use matters. He also has extensive experience representing wireless and infrastructure providers in environmental due diligence reviews, zoning and re-zoning, and land use appeals.
[1] https://www.businessinsider.com/companies-requiring-return-to-office-rto-mandate
