FOR many businesses, particularly small businesses, location is one of if not the most important factors that determines the success or failure of the business, and for the vast majority who must rent space to do business, success or failure often begins with successfully obtaining a commercial lease.
According to US-based real estate legal experts Janet Portman and Fred Steingold, there a number of key differences between commercial and residential leases.
“It’s crucial to understand from the get-go that, practically and legally speaking, commercial leases and residential leases are quite different,” Portman said. On the positive side for the business owner, there is no standard format for commercial lease agreements, because business tenants have different requirements.
“It also depends on the market,” Steingold added. “Landlords want to rent their properties, and are often willing to make concessions to sign on a tenant.” Thus, negotiations can be quite flexible.
On the other hand, commercial leases are not subject to as many consumer protection or privacy laws as residential leases, the lawyers pointed out, although they were unable to offer specifics for the Philippine market. Commercial leases also tend to be for much longer time periods than residential leases, and are in general much more binding, meaning “more difficult to change or to break,” Portman explained.
Important terms of commercial lease
According to the legal experts, there are at least 12 key terms in a commercial lease that should be clear to both the landlord and prospective tenant, and detailed in the lease contract. These include:
• The length, or “term” of the lease, which in most commercial leases is for a multi-year period. “The business owner will have to decide what’s right for his business,” Steingold said. “What is important to look at besides that is whether the lease is renewable, and if so, under what conditions. For example, will it automatically be renewed, or will a new lease have to be signed?”
• The rental price, which is usually per month but can sometimes be given as a per-quarter or per-year figure. Most commercial leases include a provision for periodic increases as well. “If automatic increases are part of the lease, try to negotiate a cap on the percentage the rent can be raised yearly, and a ceiling on increases,” Steingold said. “For instance, an arrangement that limits the yearly increase to 5 percent or less, and the overall increase during the lease term to, say, 25 percent.”
• What is included in the rent, and what is the separate responsibility of the tenant. A “gross lease” includes insurance, property taxes, and maintenance costs, while a “net lease” charges those items separately. Utilities are also usually the responsibility of the tenant, except in some relatively rare instances usually involving very small spaces. “If the space you’re considering includes utilities in the rental price, I would be wary, especially where you are (in the Philippines),” Portman said. “It’s not a common offering, but when it is, landlords almost always inflate the rates when calculating them in the rent.”
• The security deposit, just as in a residential lease, is another important factor. Its amount, whether it can be used to cover any rent – on the part of either the tenant or the landlord – and the conditions under which it will be returned, including the calculation for deducting for damage or wear and tear, should all be clearly spelled out in the lease agreement.
• What space is included in the lease is also important, even though it should be obvious. “Ask if it includes common areas, rest rooms, and so on,” Steingold said. “And ask how the space in square feet or square meters is calculated. Believe it or not, some owners will include the thickness of the walls in the space, particularly if they’re renting on an area (i.e., per-square-meter) basis.”
• Modifications or renovations to suit the business’s needs are common in commercial leases; in leases of new space still under construction, these are called “build-outs.” The exact work to be done, who pays for what, and who owns the upgrades once the lease is finished (usually the landlord does) all need to be considered.
• Who is responsible for repairs and maintenance; the experts pointed out that the most important areas to consider are heating and air conditioning, water, and electricity.
• If needed, the lease terms should also specify where signs can be placed and what kind they should be.
• On a related note, Portman pointed out that it is important to find out who the other tenants are or might be in a commercial space such as a mall or shopping center. “If you own a bookstore, you probably do not want the landlord to rent out spaces to other bookstores in the same location, so this is something you should ask about,” she said.
• Whether or not the lease can be transferred or sublet to another tenant. “This is a good feature to have if you’re not sure how well your business is going to do,” Steingold said. “Since the lease is binding, if you close shop, you’ll either be stuck paying for it, or more likely, paying a big penalty for early termination. So for some businesses it may be a kind of insurance.”
• The terms for renewing, modifying, or terminating the lease, including notice requirements and any possible penalties for early termination.
Finally, “You should always check to see what the dispute resolution provisions are,” the experts cautioned. Many landlords insist on arbitration or other alternatives to court proceedings in case of a dispute. “There is nothing wrong with,” Steingold added, “But you should be clear on what is supposed to happen if you do have a dispute, and how the process works.”
As always, the experts recommended seeking the assistance of legal or real estate professionals experienced in reviewing lease contracts to help avoid costly misunderstandings.