The Basics of Commercial Leasing (Pt 2)
My previous blog post detailed the basics of the most common types of lease agreements. However, there can be much more to a commercial lease, including important clauses that can be very impactful to the bottom line and one’s success. Those clauses will be outlined in this entry.
One important clause within a commercial lease is the Escalation Clause. The escalation clause establishes a base rental amount for the initial year, with an escalating base rent throughout the life of the lease. Landlords will build in an escalation clause to allow a new business to build their customer base while incurring less overhead to help assist the tenant in starting up the business, or as a hedge against inflation and in consideration of the time value of money. For example, the base rent may be $10.00 in year one, $11.00 in year two, $13.00 in year three, etc. A landlord-favorable clause will use an escalation based on the Consumer Price Index (CPI) without a cap. The CPI measures the change in pricing of market-based consumer goods and services and uses market factors via the Bureau of Labor Statistics provided by the U.S. Department of Labor to determine the index. The percentage of rental rate increase is determined by the percentage increase of the CPI.
Another vital clause in many commercial leases is the Non-Compete Clause. The non-compete clause is essential for both tenants occupying space in a multi-tenant building, and for the landlords leasing out the building. Non-compete clauses typically address retail uses. The non-compete clause restricts landlords from permitting future tenants from entering a commercial building or geographic area that includes current tenants that already satisfy the immediate market area. For example, if Joe’s Burgers wanted to lease a space in a strip center, yet Amy’s Burgers already rents a space and has a non-compete clause in her lease, this clause protects Amy and disallows Joe’s Burgers from being able to rent a space in the building, since it would be a direct competing use. The non-compete clause is important for a business to have in place to protect its market area. However, the clause should be structured in way that is mutually beneficial to both the tenant and the landlord. For example, a non-compete clause that states “establishments serving frozen yogurt” is less restrictive than one that states “establishments serving food”. The latter phrasing would severely limit a landlord’s ability to attract tenants. It is important that both the tenant and landlord agree on a clause that is mutually beneficial to both parties.
Leasehold Improvements, Trade Fixtures and Personal Property
When building out space for a business, it is important as a tenant to know what is classified as a leasehold improvement, trade fixture or personal property. Leasehold Improvements are improvements made to the building or space by the tenant that cannot be removed at the expiration of the lease agreement and therefore revert to the landlord. Examples of leasehold improvements are drywall partitions, electrical work, HVAC and floor covering.
Trade Fixtures are classified as fixtures relevant to the tenant’s trade or business that may or may not be removable at the end of the lease agreement depending on how the agreement is structured. If the removal of the trade fixture will cause damage to the building, most landlords will classify it as a non-removable fixture that shifts ownership to the landlord at lease expiration. For example, a fire suppression (sprinkled) ventilation hood installed over an open flame grill would be considered a non-removable trade fixture, as the removal of the hood and water lines running to the hood would more than likely cause significant damage to the building. A back bar that a restaurant uses to store items would most likely be a removable trade fixture, as the removal of the bar would not cause significant damage to the building.
Personal Property is classified as all property inside the space that can be easily removed, typically because they are unattached to any structure, at lease expiration. Items such as furniture and appliances would be considered personal property.
It is important to have an up-front discussion with the landlord to determine what would be considered a leasehold improvement, trade fixtures or personal property.
Before signing any commercial lease, it is highly recommended to review it with a qualified real estate attorney. An attorney can provide valuable feedback on the provisions contained within the lease and how to further protect your business. If you’re ready to take the first step in finding a space that suits your business needs, contact us at 304-413-4350. We can assist in negotiating lease terms that are fair for you and your business.
