By James A. Schnur, CCIM
President and Designated Managing Broker
Integrated Real Estate Solutions
LinkedIn
Lease agreements govern the landlord/tenant relationship and play a critical role in the success of the investor’s ownership of commercial property as an income-generating asset. Properly written, these agreements safeguard stable cash flow, outline maintenance responsibilities, and ensure long-term property values. But negotiating a robust lease agreement requires specialized expertise, a healthy knowledge of the market, and effective negotiating skills. The wise investor will enlist the aid of a commercial real estate broker.
Here are the steps a broker will employ when assisting you in navigating an effective lease contract.
Step 1: Define Your Goal
First, the broker must understand your objectives for the asset to align the lease terms with your long-term goals. Here are some key questions you should answer:
- What are your cash flow targets?
- What is your desired lease structure?
- Gross Lease or Modified Gross Lease – In these leases, the landlord charges a fixed rent and assumes responsibility for the majority of maintenance and fixed costs.
- Net Lease – The lease requires the tenant to pay rent plus all or a large portion of property taxes (single), or property taxes and insurance (double), or property taxes, insurance, and maintenance (triple).
- Ground Lease – This contract lets the tenant lease only the land for an extended period; the tenant retains ownership of the buildings constructed on the property for the extent of the lease.
- What level of risk are you willing to tolerate?
- How long do you plan to hold the property, and what is your exit strategy?
Step 2: Understand Key Terms and Clauses
The next “best practice” step takes advantage of the broker’s expertise in lease agreement structure, ensuring the contract clearly outlines the responsibilities of you, the investor, and the tenant of the property. The broker’s expertise will prove invaluable as you together define who takes ownership of the maintenance of the property, taxes, insurance, and other expenses.
Equally important are the items affecting ROI. For example, a broker’s experience and expertise can ensure the lease communicates expectations around rent renewals and escalations. Missing such items or failing to address them in an agreement could diminish the income value of the property.
Step 3: Evaluate the Market
In this step, the broker uses market knowledge to help you price your property accurately. Here are key questions your broker will help you answer to avoid under- or over-pricing your investment:
- What are the current market rates for rent?
- What incentives are tenants desiring?
- What are the vacancy rates and absorption trends for similar properties in the area?
- What lease terms are similar properties offering?
Step 4: Assess Risk and Negotiate Well
A broker can also help you mitigate risk and evaluate the tenant’s ability to maintain long-term occupancy. The broker can review the tenant’s financials, the lessee’s credit rating, and the tenant’s business model.
Also, the broker can evaluate the strength of the lease guarantors, those individuals or entities who will assume the lease obligations if the lessee defaults. If you own a shopping center, you will need to understand co-tenancy clauses, terms describing your obligation to reduce the tenant’s rent or allow the lessee to terminate the lease if the responsibilities of other tenants are not met.
During the negotiation process, your broker will ensure the lease includes satisfactory base rent as well as favorable escalation terms. Your agent will negotiate robust tenant commitments and strive to include landlord-beneficial terms such as common area maintenance (CAM) accounting reconciliation and subletting rights.
A broker will also help you avoid pitfalls like early termination clauses. If you are leasing to more than one tenant on your property, your agent will help you avoid tenant-favorable exclusivity arrangements, terms whereby a tenant prevents you from renting space to the lessee’s competitor.
Step 5: Enlist Legal and Financial Assistance
Brokers do not handle the legal and financial aspects of lease negotiation, but they can coordinate with professionals in these areas on your behalf. For example, your broker may call out uncommon lease language to your legal counsel; the broker’s experience brings market context to the legal review.
Using professional expertise, a commercial broker helps your accountants consider lease terms such as rent bumps and tenant improvement (TI) clauses when assessing cash flow.
Step 6: Secure Post-Lease Support
A broker can offer support, too, for those critical post-lease activities. For example, your agent can help you navigate tenant relations; their expertise and experience make brokers a valuable partner in lessee relationships. Should you allow a tenant to renew the current lease, or should you make changes to the lease when allowing a tenant to extend? Do you plan to hold the property, or is it time to implement your exit strategy? With his or her knowledge of your investment goals, your broker can help you walk through the disposition process.
Industrial lease negotiation is a complex process requiring the assistance of many professionals. Your brokers apply their expertise to protect you, ensuring your lease supports your cash flow expectations as well as mitigating risk to your asset value.
Before entering into industrial lease negotiation, consider enlisting the assistance of the commercial real estate professionals at Integrated Real Estate Solutions, Inc. They offer real estate brokerage and consulting services and follow best practices to help businesses navigate commercial lease negotiations.
Integrated Real Estate Solutions, Inc. provides clients with the in-depth knowledge and experience that is critical to determine the right path to your next move, lease renewal, or strategic repositioning of your real estate portfolio. Contact us or call 847.550.0160 today about your needs and put our success to work for you.