The Lease Doctor™ Interview
“We are what we repeatedly do; excellence, then, is not an act but a habit.”
Most restaurants operate on properties that are rented. Unless you’re fortunate enough to own the land where you want to build your restaurant, you must enter into a lease agreement with a landlord. A lease is the most important document a restaurant owner will ever sign, one that will have immediate consequences on the success or failure of your venture.
For more than 30 years, Todd Dorn has specialized in reviewing leases for tenants and making sure that they work to his client’s advantage instead of the landlord’s. Too often, landlords’ leases tend to be one-sided. Dorn, now better known as “The Lease Doctor™”, is the head of Dorn & Company, which has successfully reviewed, redlined and modified more than 2,000 leases. He’s worked with such well-known brands such as Pinkberry, Mathnasium, Miracle Method, Auntie Anne’s and Zankou Chicken.
In this interview, Dorn explains all the ins and outs of signing a lease and helps to level the playing field for tenants.
What kind of homework should a restaurant owner do for negotiations to renew a lease? We have more than a million restaurants in the United States, so there are more and more people renegotiating leases than signing new leases.
The very first thing restaurant owners need to do is they have to know when their lease expires. They have to review the contract and look at the “option language” in the lease to see what their rights are. Sometimes you have options, sometimes you don’t.
If you don’t have an option to renew your lease, it gets a little tricky. In a hot market where there’s a lot of leasing going on and there’s a lot of demand, the landlord can tell a restaurant owner that he’s got other people interested in the space. So if you don’t have an option, you have to deal with that.
Landlords typically don’t want to kick out a restaurant owner. They might not renew a lease if they can get way more money from a new restaurant owner. They can go, “Gee, I can get a dollar more per square foot—if you can give me a dollar more per square foot you can keep your place.” The negotiations are hinged upon supply and demand. If you’re in a market where there are many vacancies, the landlords can’t dictate harsh terms.
So, looking back at the contract, you either have an option to renew your lease or your don’t. If you don’t have an option to renew, the best thing to do is to start negotiating about a year in advance because you have to have a backup plan if the landlord’s not going to work with you or not going to be reasonable.
Options in the Lease Contract
But let’s say you have an option, and it requires that you give the landlord a minimum of nine months notice or a six-month notice. That’s the notification period, and it’s very important to pay attention to it. Some leases only give a 30-day window. There’s no such thing as a standard lease. It’s all custom-made; written by the landlords’ attorneys for their benefit. The key is to know what your rights are.
If you do have an option, it’s better before you give notice to exercise that option, to do research so that you can understand what the market’s doing and what your alternatives are. There are two kinds of options. There are options where the lease is based on market rate, and there are options where the lease is based on a fixed amount of money you pay in a given period. Generally, when there’s a recession and the market’s less active, landlords are more likely to give you a fixed rent because they tend to be concerned about where the market’s going to go. When landlords think the market’s going straight up, they’re hesitant to commit to a price. They’re more likely charge rent according to the market or greater.
But what the market valuation is tends to be subjective. A landlord can think his rent is worth $5 per square foot, even if there’s a landlord right around the street who’s charging only $4 a square foot. Landlords tend to have the perception that their space is better, so that they can get charge money. In the end, it’s all about the money. Unfortunately, landlords don’t look at tenants as people, to them it’s more like a spreadsheet.
Practically every lease that a tenant signs has some terminology that the tenant’s not aware of because nobody’s pointed it out to him. There are no laws that require a broker or landlord to state specific terms in an option relative to language. So one of the key points in an option that can be very deceptive is that the tenant’s thinking that he has the right to extend his lease for another five years at market rate.
Let’s say you’re over market by $1 per square foot, and you’ve got 2,500 square feet. So you’re over market by $2,500 per month. The landlord loves it. The tenant doesn’t. And the tenant thinks he can negotiate the lease based on the market—because, let’s say he’s got a five-year option based on market rent. The problem is that there might be some language in the lease that says that in no event will the option rent be less than what the tenant is currently paying. Big trap.
How come the tenant doesn’t see that?
Because he typically doesn’t know to look for it. Leases are very verbose. They’re written in legalese and there’s a lot of onerous language. Tenants by their very nature tend to be busy running or knowing their business, dealing with employees and a whole bunch of ancillary factors. They don’t sign leases every day—it’s unfamiliar territory for them. So their only choice is to either read the lease themselves or give it to an attorney. And a lot of tenants are hesitant to give the lease to an attorney because it’s an open-ended situation in which the attorney is to an extent working for himself—the longer he takes to read the lease the more money he makes. Few, if any, attorneys solely specialize in commercial leases so you end up paying for their time to research language.
Besides, attorneys typically don’t deal with business points. They deal with problems or points regarding potential litigation. For example, they might introduce language in the lease that protects the tenant from issues arising out of construction that the landlord does—that in no event can the construction interfere with the tenant’s business. Stuff like that.
So, to summarize, landlords typically tend to hold restaurant owners hostage because they know that restaurant owners have a lot of money to put into the business. If you’re an insurance agent or a nail salon owner or running a UPS store, you don’t require all the fixtures that a restaurant does. It’s easier to pick up and move. You have more leverage with the landlord because the landlord knows you can find another space that doesn’t require infrastructure such as the grease trap, the plumbing, the gas. The amount of fixed investments in a restaurant are very expensive. So a landlord knows that when he rents to a restaurant he’s gotcha! He knows that the likelihood of you picking up and moving is slim to none.
So, does real estate drive the economy or does the economy drive real estate?
They kind of have a symbiotic relationship. As the economy thrives and more people have jobs and more money is available, a lot of people may want to go out and open businesses. And the more business that open up the more vacant spaces get leased. And that drives the real estate market. The higher demand in the market, the higher the rents. And as the real estate market gets hot, there’s more money available, and more businesses thrive. So both real estate and the economy work hand in hand.
What are the fundamental differences between a residential lease and a commercial lease?
Basically, residential leases are standard leases because there are laws that regulate what residential landlords can and cannot do to homeowners. A residential lease could be a very basic two-page or three-page form, with disclosure laws. By contrast, the commercial sector, since it’s not regulated, is everything else. Landlords can put anything they want into a lease, and it’s legal. Anything goes.
Location, Location, Location
What kind of homework should prospective restaurant owners do when looking for a new location to rent?
The first thing is to zero on to which location you want to be. You don’t want to end up in a poor location, even if you get a good deal. You want to be in a shopping center or a freestanding building that has a lot of traffic. On the flip side, depending on what type of restaurant you have, you may want to be near an area that has a lot of high-rise office buildings, where people have to go to lunch. And in that case you won’t get a lot of business during dinnertime. In general, you’ve got to study the demographics. There are demographic reports that are universally available.
The next thing to do is to look at all the vacant space in the prospective center as well as the competition—what sort of businesses are already in the location where you want to be. Generally, you should look at a reasonably broad range of space sizes. If you think you need 2,500 square feet of space, you may also want to look at spaces as low as 1,800 square feet and as high as 2,700 square feet. The space maybe bigger than what you want, but the rate per square foot might be less than some other place. And you can get all this information in one of the commercial real estate subscriber-based online databases such as LoopNet. You can do your own searches for properties or you can hire a broker to do the searches for you.
Once you’ve captured all the available vacant spaces that fit your location requirement, you can start looking at prices. And always look at vacant spaces where there used to be a restaurant—a failed restaurant, say. If you move into one of these spaces, you save a huge amount of money on the infrastructure. On the flip side, the landlord already knows that you’re going to be saving money on infrastructure, so he may want more money on the rent per square foot. So you have to weigh the pros and cons there. Generally, if a landlord has a vacant restaurant, he can only rent the space to another restaurant. Otherwise he has to spend money in tenant improvements by ripping everything out.
With very few exceptions, leases are always on a triple-net basis, as opposed to a gross lease. So it’s important to ask the landlord what the triple-net cost is. For example, is it $.60 per square foot? The landlord’s not going to tell you unless you ask because he wants to get the tenant wheeled into the deal. Unlike in residential leases, where there are disclosure laws and consumer protection laws, there are no legal requirement for landlords or brokers to make specific disclosures about financial terms in a commercial lease.
The presumption is that if you’re in business you should know this already. But the problem is you probably don’t. You don’t learn it in business school and you generally don’t learn it in specific trade schools. If you try to learn it on the Internet, there are no specific books or classes on the subject. And it’s kept that way for a reason. The landlords control the ball—they control the property market, which is huge. The largest amount of wealth on the planet comes from commercial real estate. If you look at big shopping malls and office buildings, they’re all owned by billionaires, pension funds, publicly traded companies. Wall Street controls such properties and Wall Street’s in the government’s pocket. If, God forbid, the commercial real estate industry was changed, and tenants had rights and there were disclosure laws, landlords would be less profitable.
Why do brokers and landlords do business this way?
I’ve been in this business for over 35 years; you can figure it out by connecting the dots. The only material difference in the industry from 1980 to 2015 is computers. You’ve got software to figure things out. But as far as what’s contained in the lease contract, and what’d disclosed, nothing has changed. It’s all the same—it’s the Wild West.
So given a choice, landlords would rather keep tenants ill informed. That way, the negotiations are easier, the tenant makes less demands and the landlord might have more opportunity to collect more dollars.
Why is it so difficult for restaurant owners to negotiate with landlords even though restaurant owners typically raise the value of a given property? Why do landlords always tend to have the upper hand? As valuable as restaurants are, they don’t get respected. How can restaurant owners mitigate this phenomenon?
It all goes back to the money. It’s not about respect and it’s never personal. Taking advantage of the situation has been around forever and a day. It’s always difficult to leverage against a landlord in a tight marketplace. The only way to have leverage in a market where there are not a lot of vacancies is to pay attention to the language in the lease so that you can protect yourself. At the end of the day, everything is controlled by the lease and by the landlord. So the only way for any business owner to protect himself as a tenant is to have the lease contract carefully read, reviewed, redlined and modified so that the tenant doesn’t have an open-ended situation where he sees the rent going up, say, 30 percent over market, while his profits aren’t going up as quickly.
Is it a good idea for a restaurant owner to rent a space in a market that’s down or in recession?
It always makes sense to negotiate a lease for as long as possible in a market that’s down or temporarily down and you can see in the future that there’s going to be growth where the prospects for your business look good. I recommend that restaurants and dental practices, which are also substantial in infrastructure, negotiate a lease that’s at least for 10 years with one or two five-year options. If you can get two five-year options, the better.
But what if the restaurant owner doesn’t do so well in the first few years?
That’s a business risk. It’s a crapshoot, whether you sign a 10-year lease or a seven-year lease or a five-year lease. In any case, you generally can’t sign a lease that’s less than five years. But I recommend longer because if your business is going to go bust it’s going to do so sooner than five years. A landlord can force you to pay the remainder of the lease, but he has to mitigate damages. Most tenants have to personally guarantee the lease. But when a tenant is in default—he can’t pay the rent, goes into bankruptcy or is going out of business—a landlord is legally required to mitigate the tenant’s damages and re-rent the space. To an extent this is like consumer protection. It’s more or less like an implied covenant in the lease, even thought it’s not specifically said in the lease.
So if the landlord re-rents the space, the tenant is responsible for the re-letting leasing fees, tenant improvements and so forth. The thought process at work here is: how long will it take the landlord to rent the space? If the tenant has rented a good space to begin with, and let’s say after two years or two and a half years the business failed, the likelihood that the landlord will be able to re-rent the space in the next 12 months is probably pretty good, especially since it’s got the infrastructure there. And so the tenant is off the hook anyway. The fact that he signed a five-year or seven-year or 10-year lease is not going to matter. The only instance where it would matter is if the tenant has a long-term contingent liability on a long-term lease.
So you’re betting one way or the other. You’re going into business probably betting that there’s a 50-percent chance that you’ll succeed. If you fail, the likelihood of your space being re-rented is probably pretty decent. So if you sign a short-term lease, thinking you could fail, and things are going well, you back yourself up. If the business fails in two or three years and you signed a five-year or 10-year lease, the landlord still has to go through the same process to re-rent the space. And once it’s rented—after sitting for vacant for eight months, let’s say—and you’ve accumulated eight months of accrued rent in liability, once that space is rented you’re done anyway. So you’re better off giving yourself the chance of not getting stuck after a short term lease and having the landlord stick it to you.
That said, you have to be careful about the five-year or 10-year lease you signed. There are rent increases, cumulatively compounded. Typically they’re 3 percent per year. It depends on the market. What we try to do is stagger the increases—spread them out more—or minimize them. Because when you get to year seven, eight or nine in a 10-year lease, for example, on a 3-percent a year increase a lot of tenants will find themselves paying an over market rent.
Give us some tips on negotiation tactics.
There are quite a few, although everything depends on what kind of market you’re in. Generally, you don’t want the landlord to think that he has your business and that you’ve got all your eggs in one basket and you’re stuck. You always want the landlord to think that you have other options. You don’t want to give the impression that you want to rent a space really badly. Because that makes the landlord think that he doesn’t have to come down on his price, doesn’t have to make any tenant improvements.
So whether it’s re-negotiating your lease or finding a new place, and you’re speaking with either the landlord or a management company, you always want them to think that they’re not the only ones. Because at the end of the day, whether they think you have other options or not, whether they know you have other options or not, is one thing. But if the landlord doesn’t rent the space, it’s costing him money. Brokers are highly incentivized to rent spaces because that’s how they make a living—by getting a commission. But if the broker or whoever you’re dealing with has the perception that you want the space so bad—that you want it no matter what—they’re not going to come down on their price and not going to offer other incentives, such as tenant improvements. It’s kind of lying buying a car.
When talking to a broker about a space, it’s important for the tenant not only to give the impression that not only does he has other options, but to stress the benefits that his business is going to bring to the shopping center (or area).
If a tenant has been in proven business for a long time and has high credit, it’s always a good idea to impress upon the value that his business is going to bring to the property. The tenant should indicate to the landlord that renting the property to him is a much better bet than getting a new business out of the gate, which is probably not going to be so successful and where there’s some risk.
That way, the landlord knows that he has less risk that the business will go bust. So you have to sell your strong points. But the key is to not let the other side think that you’re so desperate for the space that you’ll pay anything the landlord wants.
Should a tenant customize his lease by writing what he wants into the lease? And if so, how does a tenant know what to write what not to?
That is critical because a customized lease dictates a tenant’s finances. A lease is typically a business owner’s first or second highest fixed expense. And it’s all controlled by the language in the lease. As I said earlier, there’s no such thing as a standard lease in commercial real estate. They’re all custom. And they’re all written by attorneys, modified over and over again at the behest of landlords who ask attorneys to change leases around so that they can get more money by making the leases more open-ended. Landlords will say, “We want to charge the tenant more for making capital improvements or ADA upgrades. We want to be able to have a merchants association fee, even though we don’t have one now.
So it’s the most important thing to ensure that once you’ve negotiated the lease—the rental, concessions, basic improvements etc.—to have that lease gone through with a fine toothcomb for all business and legal points. To give you an example, we recently did a lease for Utility Board Shop, a retailer that has about six or seven locations. They were opening up a new store and they sent us the lease to review. And they sent us the final Letter of Intent, which contains all the final terms agreed upon between the landlord’s side and the tenant’s side. We make sure that all those terms are contained in the lease, because sometimes there are concessions in there and free rent offered. But when you look at the lease for free rent, the free rent all the time doesn’t include the Tripe Net CAM charges. For example there’s four months free rents during a build out, but the lease says that the tenant pays the CAM charges, even when he’s not doing business.
So a tenant thinks that he’s getting free rent, the Triple Net is considered a rent, so why isn’t that free—why am I paying rent? It’s a contradiction that’s glossed over by everybody. If a tenant brings it out, the landlord’s side usually counters that what they’re doing is standard—that you always have to pay Triple Net during free rent. The tenant doesn’t know if it’s standard or not. And so the tenant goes along with the lease—he’s not going to walk from the deal over such an issue.
But neither is the landlord going to walk away. So we tell the tenant to say that while I’m not paying rent while the space is being built out, I want the free rent on my Triple Net CAMS as well.
What are CAMS?
CAMS are Triple Net expenses. The best way to understand it is to say that you own the building, but you don’t have a title. Let’s say you’re part of a complex. You, the tenant, must pay all the pro-rata (proportionate share) costs of operating the complex, no matter what. That’s why shopping centers are popular—because landlords have no expenses. When the expenses go up, they get passed on to the tenant. Every possible element of ownership that it costs to operate a shopping center—taxes, insurance, maintenance, improvements, repaving of parking lot, landscaping, gardening, redecorating, new signage, ADA compliance, replacing HVACs, anything—all gets passed on to the tenant.
So going back to the Utility Board Shop, the company was about to sign its lease and didn’t know that there was a merchants fee in there. Nobody told them—it wasn’t in any prior documentation. And it was $400 a month for 60 months.
What’s a merchants fee?
It’s an association or membership fee set up by the landlord. We believe it’s just like a profit center—like a homeowners association. Landlords will tell you that it’s to promote the center, but it’s very vague, very grey, containing language such as, “We do this in the best interests of the tenants ..” It doesn’t have any specifics such as whether the landlords is going to run ads, have a billboard, things like that.
Wait, so the bit about the merchants fee written in the lease—how come the tenant didn’t notice that?
It was in the lease contract but not in the final offer. When a tenant signs a final offer, he looks at things such as his rent, increases in the rent, how long the lease is, how much it’s going to cost per square foot to do tenant improvements, and the fact that he got five months free rent. Nobody is required on the landlord’s, broker’s or management company’s side to tell the tenant, “Oh, by the way, there’s a merchants fee in there for $400 a month you’re responsible for.” It’s left up to the tenant to find it—in the lease. If the tenant doesn’t find it and signs it, oh well, too bad, you’re stuck for it.
So in this case of the Utility Board Shop, there was no mention of the merchant fee in the final offer. Nobody ever discussed it. Sometimes there are merchant fees in leases that are not currently being done but the landlord has the right to do them later—and they can charge whatever they want. So, when we talk about customizing a lease, we always recommend that the tenant scratch it out, redline it. Most landlords, if they’re not collecting merchants fees presently will scratch it out because they don’t want to blow the deal over it. In the case of the Utility Board Shop, we told them that the merchants fee was not disclosed to them in the final offer. And they were able to go back to the broker and when all was said and done, the landlord chopped the fee in half. The tenant still wanted the space—didn’t want to lose the deal—and the landlord didn’t want to lose the deal. Keep this in mind—that landlords don’t want to lose deals, even though they want everything they can get. And a lot of that is buried in the lease contract, which the tenant usually has no way of getting at, let alone understanding. And, unless the tenant already has maybe 80 stores and a real estate department that’s been dealing with leases for 20-30 years, the tenant has no way of knowing what’s standard, what’s normal, what’s customary and what’s not.
And that, mind you, is just the tip of the iceberg. There are numerous provisions in a lease contract that have to be changed for the best interests of the tenant to be protected. For example, assignment subleasing, which involves the tenant selling his business. Most contracts will say—in fine language covered under the subject of rent—that the landlord has the right to share the profits from the sale. That’s because rent has a definition—and it literally has dollar signs all over it. Consequently, anything with a dollar sign on it is considered rent. Leases will say, for example, that rent is considered as base rent, CAMS—and any other financial consideration. So if a tenant is receiving money from a prospective purchaser, the landlord, in most leases, will have the right to highjack that consideration. Moreover, the landlord often has the right to recapture the lease in a lease assignment. So, one of the very important things to read carefully, or have an expert go over, is to ensure whether the landlord has the right to take 50 percent of the profits from a business if and when the tenant sells it. Attorneys are not well-versed in this subjet matter because they don’t do it every day and don’t learn it in law school.
How can prospective restaurant owners find someone such as you who understands leases?
Unfortunately, they don’t. And that’s all by design, because the industry is controlled by landlords. It’s their property, their power, their money. And brokers and real estate advisors support this structure. The only way tenants can find help is to search on Google. That’s where the Lease Doctor will show up. Now that we’ve built up a critical mass of clients, we’re marketing ourselves on databases like LoopNet and other mediums, making people aware that these types of services are available. Before a tenant signs a lease, we charge a flat fee of $395 to review the whole contract. It’s a fraction of what attorneys charge, and we cover all the business aspects. Plus we turn the document around in a few days. An attorney can hold up a deal for two or three weeks, which upsets everybody.
Talk a little bit about how tenants can protect themselves against Triple Net charges. We have a landlord who charges Triple Net, which is around $1,700 per month. But they do no gardening—there are no plants except for a few cacti. And they don’t do anything to the parking lot—there are no lights, yet they have maintenance charges. So how do people fight back against such charges?
There are only two ways to fight back. The best way is to have protection in the lease contract. Make sure that there’s a cap on expense increases in the lease. A lot of landlords will do this. So you have to control what currently is being paid and what goes up. What we always look for while reviewing a lease, even if it’s not in the final offers, is that increases on Triple Net are capped at 5 percent per year. Sometimes landlords won’t agree to cap everything, but they’ll cap the controllable items, such as maintenance, landscaping and management fees. These are items landlords have control over, and they can’t just increase them to make more money off the tenant. The other thing to do is to ask for exclusions in the operating expenses. There’s a whole list of exclusions.
Remember, there’s no such thing as a standard lease. The language in a lease is often open-ended, such as: “The landlord may charge including but not limited to …” We recently reviewed a lease for a retail franchise that said each year the landlord will make a determination of what the expenses will be the next year and that the landlord will tell you how much it is. We always say that the landlord needs to give a detailed and itemized statement of Triple Net expenses, such as taxes, insurance, maintenance, replacements, parking lot, landscaping. That way, each year a tenant can track what it is going on each year.
Let’s say you sign a lease in which the landlord says that his Triple Net expenses are 60 cents per square foot. We always say that should be fixed for the first year of the lease because the tenant can come in thinking his Triple Net expenses are 60 cents per square foot but three months later they could be 80 cents per square foot. Triple Net is like a black box. Unless a landlord is required to itemize the expenses, it remains a black box.
Can the tenant ask to see receipts?
Usually a lease will contain language that the tenant has the right to conduct an audit of expenses. But a tenant usually doesn’t know what to do in an audit. He has already run into enough trouble trying to get the deal done; now he’ll spend more time trying to unravel the black box. You could have a landlord who owns a shopping center. Let’s say it’s a shopping center that has been owned by a family for 20 years and the landlord wants to sell it. Over the years, the taxes on the shopping center have gone up astronomically. And who pays that tax increase? Not the landlord—it’s passed on to the tenant.
How important is it for tenants to measure the space they want to rent, given that landlords can overestimate how much the square footage is? Should tenants get a third-party estimation of the space measurement before signing the lease?
We always recommend that a tenant do that. But the key is to know how to measure a space. It takes very little time, and there are a lot of tricks to do it. Many ceilings, for example, have two by four tiles. You can count the tiles each way. Walls are usually six inches thick. Take half that, add it to the width. If you’re being told before you sign a lease that the space is 2,000 square feet, for example, and indeed it is 1,700 square feet and you can make the argument for it by telling the landlord that you field-measured the space and that it’s off by 300 square feet, it’s well worth your time and effort.
There are some reasonable standards. For example, the thickness of the walls is always included in the square footage. Let’s say you’re renting a space and you’ve got a tenant on each side of you. Let’s say the wall on each side is a foot thick. So the tenant would pay half the thickness of the wall on both sides. Now, you also have the rear and the front of the space. The tenant will usually pay up to the exterior glass line of the space and the exterior wall. That’s what it should be.
Sometimes landlords use standards such as BOMA, that is, Building Owners Management Association, which are generally geared toward office buildings. Just the other day we reviewed a lease that stated that the tenant accepts the square footage the way the landlord states it. Which means that if the square footage of the space a tenant is occupying is actually 300 square feet smaller than what the lease specifies, that’s too bad.
So yes, sometimes landlords do exaggerate their square footage and prefer not to have the tenant measure the space. Or a landlord may think he’s got a space that’s 1,500 square feet—he purchased the space based on 1,500 square feet—but in reality it’s 1,200 square feet. They don’t want to collect rent on 1,200 square feet. But if a landlord doesn’t agree with your reasoning, try to get something taken off the rent in exchange.
When a potential tenant approaches a lease specialist such as you, how important is it to ask whether that specialist also represents landlords to determine if there’s any conflict of interest involved?
It’s very important for a tenant to know who they’re dealing with and which side they represent. Our mantra is that we strictly represent tenants. Generally a tenant won’t ask us if we represent landlords too because we make it clear on our website that we strictly represent tenants. But it’s so important for tenants to know who is on their side.
Given the obvious importance of lease specialists for tenants, why hasn’t there been an organization over the years around which lease specialists have coalesced to represent tenants?
You have to go back to the basics of real estate. Most people start out as brokers and then might branch into other areas. And the only way a broker can make a living is by having listings of property. That’s what I was taught when I went to real estate school in the late 1970s, and the same is true today. It’s harder to get business from a prospective tenant because you don’t have anyone calling off a sign posted on a property.
So that becomes the direction and focus of the business when a broker first starts out. That’s what’s drilled into prospective real estate agents before they get licensed. And after they get licensed they’re taught that they need to cold call landlords to get listings, and that when they finally get listings they need to cold call tenants to try to fill the listings. So the broker’s income is derived from the landlord because that’s who has the money. Almost the entire 100 percent of the industry is driven, controlled and run by the landlord side of the equation. So the idea that there can be a body to represent tenants has been drained by default from the industry’s inception. And there’s nowhere to go.
We once had a situation in which the landlord wanted free food for up to $30 a day. And I obliged because I wanted more parking from the landlord.
That’s a good example. A commercial lease can have anything and everything. Once you agree to the terms and sign the lease there’s nobody there to protect you or help you out because you’ve already signed it.
On a side note, we were once called in on a case in which there was a major school district that had rented 65,000 square feet. They had a lawyer and a broker representing them. But the lease was full of holes—it was open-ended and left the tenant with multiple and potentially terrible legal exposures. This was a public institution—a school district—and there were many things it was not aware of in the lease. The school district signed the lease, and some tax payers got wind of it. It became a highly political and controversial lease because it was public information. Long story short, about four months after the lease was signed, I was contacted by a political tax-payer group in the district to see if I could help.
So they brought us in to see if we could renegotiate the lease, get the tenant out of the lease, anything we could do. There was serious misrepresentation on the broker’s side because it was a dual agency and all the broker’s loyalties went to the landlord. The tenant was not aware of all the details they were signing. There were things even in the final offer that never made it into the lease. We felt that at the minimum the brokerage firm that represented the tenant but also represented the landlord had exposure and liability for misrepresentation and negligence and potential DRE ethics violations.
The school district didn’t want to get into litigation over such an issue, but it knew that was an option. What we ended up doing was red-lining the lease and brining it out in a public meeting attended by more than 200 people. The landlord and all his lawyers and brokers were there, and they weren’t happy. But I had to expose what I saw. We went through the whole contract and discovered that there was a huge hole in the lease that actually worked against the landlord. If we navigated the lease going forward according to the terms of the lease, intelligently, without breaching, there would be a potential out for the tenant.
Now, the landlord didn’t know what we knew. It was all kept behind closed doors. Several months after we were hired, we were able to use the out clause in the lease for the tenant because the landlord was not able to commit certain obligations he was committed to. And that would be determined a breach of the contract, leaving the tenant with the right to cancel.
Even the landlord wasn’t really familiar with the language that would have exposed him legally in the lease. We exposed it and we forced the landlord to come to the table to either renegotiate the lease or the tenant was going to kick out—cancel—because the landlord wasn’t going to be able to perform certain obligations. Just as a landlord can go after a tenant who doesn’t pay the rent on time, we were able to go after the landlord.
But all along, we advised the school district not to indicate to the landlord in any way how reliant the district was on the 65,000-square-foot space it had rented. We told them to let the landlord know that the district had a Plan B in case anything went wrong. And the landlord didn’t want to lose the tenant—he already had the space vacant for a significant period of time before the school district moved into it. So again, going back to what I said earlier, it’s always important to let the landlord know that he doesn’t have you, that he’s the only game in town.
What’s the difference between a Triple Net lease and a Gross lease?
In a Gross lease, the landlord pays all the expenses, but each year, as those expenses go up, that component gets passed through to the tenant. In a Triple Net lease, all the expenses are paid by the tenant. So if expenses in a Gross lease go up by $1,000 and the tenant has 10 percent of the building, the tenant pays 10 percent of the $1,000. By their very nature, therefore, Triple Net leases are more expensive than Gross leases.
Let’s say you’re paying $2 per square foot gross. Besides your $2-per-square-foot rent, the landlord pays for all the taxes, insurance, maintenance, repairs, replacement, landscaping etc. After a 12-month period of time—and this has to be negotiated ahead of time—the tenant has to pay any increase in expenses over the base year in which the lease was signed. The rub is that if the tenant signs a gross lease at the end of, say, October 2015, he’s going to get hit with what’s called an operating expense increase in three months. So we advise tenants to make sure that the lease specifies that any operating expense increase doesn’t occur for the first 12 months.
What are some of the elements of accountability or responsibility between a tenant and the landlord regarding repairs undertaken in a leased space? What are some of the key issues to watch out for in grey areas such as not just who pays for the repairs but who actually gets the repairs done?
Again, everything in the lease dictates what is and what isn’t. Verbal understandings don’t mean anything. In a Triple Net lease, the tenant is responsible if anything breaks, such as the roof or HVAC air conditioning. A lot of times the landlord will make the repairs and bill back to the tenant. Most of the time, the tenant is required in the lease to maintain a contract with a certified company that comes out periodically and tests the HVAC system and maintains it. Typically, in a Triple Net lease, the tenant maintains the HVAC system, although the landlord has the right to do this himself. Like everything else, it all goes back to the way the lease is written.
What are your top three Do’s and Don’ts for signing a lease?
The Do’s: First, review your lease and final offer very carefully. Make sure everything you bargained for is included in those two documents. Have a knowledgeable third-party go over your lease so that you can be aware of any potential financial exposure to you. Check all the math because mistakes that work in the landlord’s favor do happen.
Second, do your research carefully as to what the market conditions are relative to rent rates, additional charges and concessions. This will help you negotiate with the landlord intelligently.
Third, arrange for an independent, unbiased third-party negotiate on your behalf instead of letting the landlord’s broker represent both sides. This will help you avoid any inherent “Dual Agency” conflict of interest in the negotiation.
The Don’ts: First, don’t rush or feel pressured into signing a lease quickly, even if you’re told that other people want to rent the same space you’re interested in renting.
Second, don’t make assumptions based on verbal representations from the landlord’s side. Anything verbally communicated to you goes by the wayside once a lease is signed.
Finally, don’t sign a lease unless you understand the full and actual costs, including tenant improvements, associated with leasing a particular place. Far too many tenants underestimate these costs.