Chris Stephens: Complete lease essential to protect rights, investment

Chris Stephens

A complete lease is essential for both landlords and tenants.

A lease document is extremely important to the landlord and tenant because it provides the legal right to use, without owning, real property. It describes the terms, obligations and responsibilities of each party's to the lease.

Defining the rent amount and use of the property is critical to the landlord's investment in the property. A lease is not canceled when the property is sold. It is assumed by the buyer. So the owner needs to make sure that the leases are complete in order to be acceptable to a buyer.

To a business, the terms of a lease are very important because they provide the provisions needed for business operations.

The legal provisions and language of commercial leases need to be negotiated by real estate attorneys with the business provisions covered by the brokers. While an attorney can be expensive, paying for sound legal advice to have a complete lease is cheap insurance compared to the cost of problems that can result from an incomplete lease.

When questions or problems come up without a complete lease document, such as a form lease from the Internet, then the landlord and tenant are faced with trying to reach an agreement. This can lead to serious and expensive resolutions.

Here is a summary of some basic provisions that should be in all leases. Realize, however, that different types of properties need different provisions. For example, a retail space might base its rent on the sales of the tenant. This provision would not be in an office or warehouse lease.

In the following summary of provisions, I sometimes refer to the leased property as the "space." But this could be an entire building.

Identify the landlord, tenant, and property being leased, dates of occupancy, commencement and termination, and rent for each year of the lease.

Identify who is paying the operating costs such as utilities, janitorial, maintenance, snow removal, taxes and insurance.

If operating costs are to be paid by the landlord, there often is a provision for an adjustment in the lease rate to cover increases in operating costs over the term of the lease. This is called a "pass through" or "expense stop" and is included to keep the landlord's net income from declining as operating costs increase.

What an operating cost is has to be defined. For example, interest expense and depreciation are not operating costs. Contributing to a reserve to replace expensive items such as a boiler is generally considered an operating cost.

Describe the condition of the space at the commencement of the lease as well as any changes that will be made to the space (tenant improvements) such as moving walls, who pays for this, and who is responsible for the construction of that work. Also cover what changes the tenant can make to the space during the term of the lease (usually a dollar amount for each change) without first obtaining the landlord's approval. Describe what the condition of the space will be when returned to the landlord.

Describe any options. Options can be written for all kinds of things such as the tenant extending the lease, or taking more space, or giving up space, or having a first right of refusal to lease additional space, or the landlord having the right to cancel the lease.

Any option needs to clearly describe all the provisions that go with it. For example with a right to extend a lease the option needs to describe when the tenant has to provide notice of exercising the option, what the lease rate will be for the option period, and any other items such as tenant improvements.

Tenants have the right to sublease with the landlords' reasonable approval. But the lease needs to address notice, when the landlords permission is not required, (such as to a subsidiary) who does the tenant improvements, what happens to the subtenant if the tenant defaults, and so forth.

Insurance needs to be addressed; describing the type and amount of insurance the landlord and tenant will each carry.

What happens if the building is severely damaged, burns down, or if part of the property is taken by condemnation for say to widen the road and this reduces the parking.

The landlord needs a "Subordination" clause where the tenant agrees to subordinate its lease to any new financing on the property. Without this, the landlord or a buyer will have difficulty in obtaining financing because the lender will want to be senior in claims to the property to any lease.

The tenant needs an "Attornment" clause. In the event of a foreclosure, the lender agrees to honor the lease as long as the tenant meets the provisions of the lease. Without this clause, the tenant runs the risk of being forced to vacate the property in the event of a foreclosure.

There needs to be a provision for tenants agreeing to sign what is called an "Estoppel Certificate" that confirms the lease. This is important to the owner because a buyer is going to want to make sure the lease the seller provides is the same lease the tenant agrees is its lease.

The lease document does not need to be more comprehensive than the property and lease. A class A office lease to a multi-national company for a large amount of space can go on for more than 30 pages detailing all these items and many more. A lease for a small amount of space can be much shorter and simpler, yet still needs to cover the basics.

Chris Stephens, CCIM, is a local associate broker specializing in commercial and investment real estate. His column appears every month in the Daily News.

Chris Stephens
Real Estate