Top 10 Mistakes with Commercial Property Leases

After salaries, commercial property lease expenses (rent) are generally the second highest expenditure item for a business. The impact of your commercial property lease goes far beyond the bottom line; it plays an important part in employee retention, the level of workplace productivity and morale. It is for these reasons that businesses should work on ensuring that their commercial property lease is structured in a way that allows your business to thrive.

The following is a list of the top 10 mistakes that business owners frequently make with regard to leasing or renting office space:

1. Not Understanding the Make Good Clause:

When your lease comes to an end, you have an obligation to ‘make good’ or repair the office suite you have used and put office space back into the condition the commercial suite was in when you first rented it. What is fair is largely dependent on your particular circumstances, however, what is typical for commercial property is an obligation that you remove all fixtures and fittings, repair any damage, repaint the suite, make good or possibly replace the carpet and carry out a professional clean of the suite. Most businesses do not realise that you must carry out your make good works before your lease expires.

2. Not Designing your New Office Space Prior to Lease.

Similar to not understanding the make good clause, many prospective tenants fail to have an architect or interior designer lay out their office space or do a test-fit.  In a tenant’s market, many landlords will allow a prospective tenant to have the landlord’s interior designer organise a simple space plan on behalf of the prospective tenant to ensure that the space will be sufficient for the prospective tenant’s needs.  Failing to do this in advance of signing a lease may cause a tenant to end up with office space that does not properly meet its business needs.

3. Not Understanding the Commercial Property Expenses.

When leasing office space, there is typically a base or ‘net rent’ that is based on a price per square metre, along with the tenant’s responsibility for payment of a percentage of the operating expenses or outgoings of the building. Some office leases are for a ‘gross rent’ which basically means whatever your rate per metre is, multiply that by the area of the office space and you have an actual annual rent for the figure that you will need to pay.

What is very common is a hybrid of the two types of lease where the tenant pays a gross rent with increases in outgoings on base year, or the year you start occupying the premises. The increase in outgoings on base year is calculated by working out the increase in outgoings from one year to the next and then multiplying that figure by the percentage of the total building area you occupy. In most circumstances, particularly for small tenants the dollar amount for the increase in outgoings over base year is nominal.

When signing a lease for a net rent it is very important for a tenant to understand what the operating expenses of the commercial property were in the previous year or two.

4. Not Reviewing the availability of Parking.

Not only is it important to review the current number of parking spaces in the building and whether there is a reserved parking space regime in effect, but also the cost of leasing car spaces even if you do not currently need to rent a car space.

5. Not Asking Questions about Signage.

A prospective tenant should be sure to ask questions and understand what signage is allowed, what signage will be prohibited and what approval rights the landlord will have in regard to signage.  Is exterior building signage allowed and if so, are there any limitations?  Is there a tenant directory board in the commercial property’s lobby that lists the names of each company in the building?

6. Not Anticipating Future Growth or Contraction.

In a large office building or commercial property, it is sometimes possible for the landlord to completely relocate a tenant if you need additional office space, however it is more practical for a tenant to grow without having to move.  As part of the lease negotiations, it is sometimes possible for the tenant to have a right of first refusal to lease some or all of the adjacent office space when a neighbouring tenant leaves.  To the extent that the tenant is requesting a right of first refusal, then it is also wise to understand the length of the remaining lease term for the adjacent tenants along with any lease renewal or options.

7. Not Contemplating the Need to Assign the Lease or Sublet the Space.

It may be very important to negotiate the assignment and subletting provisions of the lease.

To the extent that the tenant may need to sell their business or the business’ underlying assets or merge with another company during the lease term then it is wise to determine what type of approval is needed by the landlord to permit an assignment of the lease to another party and whether any guarantors of the lease may be released from their obligations.  Is an objective standard provided for by the landlord such as the assignee having a net worth at least equal to or greater than the tenant at the time the lease was signed?   Can the landlord refuse to grant its approval in its “sole and absolute discretion” or must the landlord use “reasonable discretion”?  Is there a review fee and/or solicitor’s fees that the tenant will be charged by the landlord or the landlord’s solicitor for reviewing the request and preparing any necessary documents?

With regard to a sublease, it is equally important to understand the approval rights of the landlord.

8. Not Understanding the Fit Out Works.

To the extent that the office space is not ready for the tenant’s immediate occupation and needs to be fitted out to suit the tenant’s needs, then the landlord typically provides a letter that specifies what fit out work the landlord will be doing or how much of a financial contribution will be provided for the tenant’s benefit in this regard.  If the landlord or landlord’s contractor is performing the fit out, then it is important to understand whether the fit out allowance will be sufficient or whether the tenant will need to expend additional funds.  It is important to understand whether the landlord is charging overhead, profit or supervision on top of its general contractor, or if the landlord is self-performing the work then what “soft” costs will be charged to the tenant.  If the landlord or landlord’s contractor is performing the fit out, then the tenant will still need some time after the  fit out is complete to install its phone system, computers, furniture and other items.

9. Not Reviewing the Commercial Property’s Base Building Systems.

Prior to signing a lease, it is important for a tenant to ensure that the commercial property’s capacity for electrical, networking, and heating, ventilating and air conditioning (HVAC) are sufficient to support the tenant’s needs.  What type of internet connection is currently available to the commercial property and what bandwidth is available on this network?  To the extent that the tenant is looking to use a voice-over-internet-protocol (VOIP) for its telecommunication needs, then it is important to understand whether the commercial property can support this or whether additional communications lines will be required.  To the extent that the tenant has special equipment for its industry (i.e. medical tenants) or has more electrical equipment than is standard for a traditional office user (i.e. computer data center), then it is important for the tenant to ensure the sufficiency of electrical and HVAC systems.  If these systems are not sufficient, then the tenant may need to spend additional sums in upgrading the commercial property’s electrical system, installing supplemental HVAC systems or back-up generators or redundant power supplies. If you work long hours or on weekends, then you should also enquire as to whether or not the commercial property offers after-hours air conditioning and the associated running costs.

10. Failure to Negotiate.

If as a business owner you are interested in leasing an office suite in the commercial property, however, the financial or lease terms are not to your liking, then make a counter-offer. While there are always limits to what a Landlord will accept as a fair market rent or fair commercial terms to a Lease, often there is room to negotiate to ensure the lease deal for the commercial property is fair to both Landlord and Tenant.