Panama City Commercial Real Estate | Panama City Beach

Introduction to Leases - Part 3

Other Important Commercial Lease Clauses

Several other options and clauses are designed to protect the needs and concerns of the owner and tenants and should be negotiated carefully.

Lease Renewal Options

Many commercial leases grant a tenant the right, but not the obligation, to renew a lease for prespecified period of time after the initial lease expires. The rate at which the lease can be renewed is specified in the initial lease contract. A renewal option is valuable to a tenant because it eliminates the need to find an alternative location for the business when the current lease expires. However, because the tenant is not obligated to renew, the tenant is free to seek another location if the tenant desires.

Expansion and Relocation Options

Most businesses seek growth. Therefore, it is imperative that the lease give the tenant the right to occupy additional space in the office building or shopping center, after a specified notice period, at market or defined rental rates. In some cases, the owner will agree to give a tenant the right of first refusal when space becomes available in the building or center. In other cases, the owner will agree to relocate the tenant within the building or shopping center as soon as possible, if additional contiguous space cannot be provided in a reasonable time frame. Clearly, these clauses should be negotiated and worded carefully.

Important Lease Considerations for Owners

Owners of commercial properties seek reliable tenants who pay rent on time, take care of the property, cooperate in allowing reasonable access for inspections, and use the property as defined in the lease.

The credit worthiness of commercial tenants usually depends on their ability to operate a business profitably. Thus, commercial owners usually analyze the need for a tenant’s business in the community and the tenant’s abilities to operate the business. Additionally, owners analyze a tenant’s management structure, financial strength based on credit reports and financial statements, and competitive market position.

Certain types of businesses are quite compatible with each other, whereas others detract from one another. For example, dress shops and shoe stores help attract customers to each other, but a mortuary may repel customers of retail stores. Reputation and prestige also affect surrounding businesses and, ultimately, property values. Highly regarded tenants contribute to the desirability of an office building or shopping center.

Many tenants require specialized space or equipment. For example, physicians and dentists require small rooms and specialized plumbing. Lessees usually provide any special equipment, but they expect lessors to install items regarded as part of the real estate, including plumbing, electrical service, sinks, stoves, and cabinets. Who provides what should be delineated clearly in the lease.

Important Lease Consideration for Tenants

Commercial tenants have some concerns similar to those of owners. They want properties that are compatible with their uses, are well located for their business, are well maintained, and enable them to operate their businesses profitably. The property’s location and physical characteristics should meet the tenant’s needs. Many commercial businesses rely heavily on traffic and access appropriate to their use. A good location for a show store, for example, might not be the best location for a physician’s office.

The physical characteristics of the site and building must be considered. Is the size and type of space appropriate? Is there ample parking? Is the building in good repair and well maintained?

Negotiating techniques and skills represent powerful tools in determining commercial lease provisions. Owners and tenants serve themselves well by mastering the art of negotiation.

Financial Impact of Lease Clause Decisions

After a decision has been made to lease and the markets have been researched, the client may have several alternatives to choose from. You may be called on to prepare a report that financially quantifies a user’s lease costs and economically compares and contrasts alternative leases. As mentioned, the final lease terms will be dependent on current local market conditions and the negotiation skills of the parties involved. This section analyzes the quantitative costs that the lease imposes on the user. Some commonly used terms will be defined below. These terms and definitions often vary from market to market.

Base (contract) rent: This is a face, specific, defined, contract dollar amount of periodic rent. The annual base rate is the amount upon which escalations are calculated.

Total effective rent: This is the base rent adjusted for concessions and allowances and for costs that are the responsibility of the user (such as operating expense pass-throughs). Total effective rent is the total of all cash flows over the term of the lease.

Total effective rate: This is the total effective rent divided by the square footage.

Average annual effective rent: This is the total effective rent divided by the total years of the lease term.

Average annual effective rate: This is the average annual effective rent divided by the square footage.

© Copyright 2008 Jennifer MacKay. All Rights Reserved.

Introduction to Leases - Part 4

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