Management
Legal Insight

Commercial Leases

November 2, 2012
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 Compare costs, modifications and other lease terms. 
 
Real estate (property) is an economic resource regulated principally by municipalities and states. There is no single real estate market. Rather, there are many markets. Conditions may differ among them depending on local regulations and the local economy. While some macroeconomic factors (such as interest rates) can simultaneously affect many or most markets, buying or renting property is a microeconomic decision. 
 
Tenants and buyers have unique needs, and properties have unique characteristics. To determine whether specific properties meet a party’s needs, one must understand the property’s features, inherent risks and intrinsic value in relation to the sales price or rent. One must conduct due diligence to understand a property. Among other things, one can view it, hire contractors to inspect it, and hire professionals to review relevant documents.
 
The previous column discussed the commercial leasing environment, negotiating leverage, zoning, and environmental contamination. This column analyzes some important lease terms. It cannot cover everything that landlords and tenants should know about leases. Leases may be lengthy and terms may vary. A knowledgeable attorney should draft or review them.
 
Rental properties may have different configurations and layouts. Buildings offer different amenities. Prospective tenants probably want to compare square footage and cost per square foot (sq. ft.). Such comparisons may not be as straightforward as they would seem to be. Landlords or management companies use a variety of conventions to measure space. If tenants measure a unit with their own tape measure, they will likely observe that their measurement differs from the advertised square footage. The landlord might be measuring space from the outside, middle or inside of walls. Thus, dimensions may include unusable space.
Buildings have common areas such as lobbies, hallways and elevator banks that must be illuminated, maintained and climate controlled. As furniture, carpets and machinery depreciate, they must be repaired or replaced. Tenants should not assume that they will have the use of these areas for free. Landlords may charge tenants for common areas by using a “loss factor” or “load factor” in the lease.
 
When a lease uses a loss factor, the square footage quoted includes exclusive space and common space. The loss factor is the amount of the common area allocated to the tenant and subtracted from the total space. For example, a space may be advertised as 5,000 sq. ft. If the tenant’s proportional share of common space is 500 sq. ft. (i.e., the loss factor), the tenant has 4,500 sq. ft. of exclusive space. The tenant pays rent on 5,000 sq. ft.
 
When the lease uses a load factor, the common space is expressed as an additional charge. A space may be advertised as 4,500 sq. ft. (i.e., exclusive space), but the load factor would require the tenant to pay for its proportional share of common space—in this example, 500 sq. ft. (Loss and load factors may be expressed as percentages.) To compute and compare costs per square foot, tenants must understand how much space is usable and how much exclusive or common space they are leasing. This requires some analysis.
 
Another important issue is whether space is fit for its intended use or must be modified. 
 
The lease should address who is responsible for alterations. Landlords own capital improvements, which are structural and add value. Tenants own non-capital improvements that they pay for. They are not part of the unit’s integral structure and can be removed without causing damage (for example, decorations).
 
Landlords own fixtures that the tenants attach to the property. These cannot be removed without causing damage. Tenants own trade fixtures, even if they are attached to the property, and chattel (i.e., personal property), which are not attached. To avoid disagreements, the lease should clarify ownership issues where possible.
 
Parties should agree who will handle construction work. The landlord will want to ensure that the contractors are licensed and properly insured or bonded. Both parties will want to ensure that the modifications comply with local building codes and, where appropriate, the Americans with Disabilities Act (ADA). Also, the parties should agree on what happens to modifications at the end of the lease. The landlord may want the unit restored to its original condition or may be pleased to keep the modifications if they enhance the unit’s marketability and value.
 
Editor’s note: This column does not constitute legal advice.

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