This post originally appeared on Burt M. Polson’s Real Estate Journal and is republished with permission. Find out how to syndicate your content with theBrokerList.
Photo by Avi Richards on Unsplash
With rent being one of the most significant expenses, a tenant desires the best terms and conditions to keep the rent and expenses low. A landlord is looking for the best return possible.
But, that is not all there is to consider in negotiating a lease or, if you are an investment real estate buyer, the terms of the current leases in place.
Part one discussed rent, term, and the early termination clause. Below we will highlight tenant improvements, options to buy, and the format of the lease agreement.
Tenant Improvements
There is a difference between tenant improvements (TIs) and refurbishing or updating a space. A tenant improvement is usually made as part of negotiations in bringing in a new tenant. You could consider three types of TIs: new construction, tenant required, and general.
In new construction, a tenant may be offered an unfinished space called a “plain vanilla shell,” which has the basics except for wall and floor finishes and possibly a ceiling. A developer may provide a TI allowance for finishing the space to the tenant’s specifications.
Tenant-required TIs are geared to the tenant’s use. Converting a space to a restaurant, for example, thereby requiring a commercial kitchen, is a tenant-required use and is usually at the cost of the tenant.
General TIs could be upgrading the electrical service, updating for ADA (Americans With Disabilities Act) requirements, or reconfiguring the space. The payment of such TIs could be negotiated as these upgrades may improve the space for future tenants.
TIs should not be confused with refurbishing or updating a space. An old and tired space should be updated to entice a new tenant. In addition to new finished surfaces, this could also include an updated door and window line, new lighting, or an updated restroom.
Option to Buy
You may find during negotiations a tenant desiring to add an option-to-buy provision in the lease agreement. This is not unheard of, especially if a tenant performs hundreds of thousands of dollars in TIs. They would want the option to purchase the property if the landlord chooses to sell.
There are several different types of options available, each having its own requirements and triggers. Two options to consider are the Right of First Offer to Purchase and the Right of First Refusal to Purchase. These should not be confused with the lease option.
The options to buy are a bilateral agreement where both parties must agree to sell. A lease option is a unilateral agreement as the landlord already agreed to the sale with the tenant under specific terms. The tenant then has to decide at a future date to initiate the sale.
Format of Lease Agreement
Popular are three boilerplate lease agreement companies that produce several different lease agreements depending on the property and basic terms in the industry. We use these daily and are familiar with the terms and conditions enough that we usually do not need to seek outside counsel.
However, often a landlord or corporate tenant opts for their own lease contract because their counsel created it with terms in their favor. When this occurs, outside counsel is usually sought to determine the agreement’s contents and how it will affect the landlord-tenant relationship today and ten years later.
Commercial leasing is different in two important ways; first, the lease agreement remains in effect for many years, unlike a purchase agreement transaction completed in a few months. Second, purchasing a leased investment property is usually subject to the leases, so be sure as a landlord you know what to expect.
Burt M. Polson is the CEO of ACRESinfo.com, a commercial real estate brokerage company, and CEO of StoneMarkerInvestments.com, a private equity real estate fund. Call him at (707) 254-8000 or email [email protected] and [email protected]
