The Legal Way Episode 4 | Leasing Lessons (Part 1): Exploring Lease Provisions For Landlords

In part 1 of a two-part leasing lesson mini-series, join The Legal Way Podcast and Friedman Schuman real estate attorney, Peter Friedman, as we focus on landlord lease provisions, providing a comprehensive overview of key terms and clauses designed to safeguard landlords’ interests, enhance property management, and ensure legal compliance. Whether you’re an experienced property owner or a novice in the real estate market, this episode serves as an essential guide to understanding and crafting effective lease agreements that protect your investment. Stay tuned for the second episode, where we will dive into tenant lease provisions!

EPISODE TRANSCRIPT:

Alyson: Hi everyone and welcome back to the Legal Way podcast by Friedman Schuman. My name is Alyson Layser and I’m your host. I’m also the director of marketing here at Friedman Schuman. Today I’m going to be joined by two guests who are also two attorneys at our firm, Peter Friedman and Lee Mogavero. I am so excited that they are joining me today because we are gonna be diving into the topic of provisions in a commercial lease for landlords. And this is such an interesting topic. They have a lot of great insight to share. So, I’m really excited for us to dive into it. Before we go into today’s topic, I’m going to have Peter and Lee introduce themselves and then we will dive right in and they’ll take it away. So, Peter and Lee, please feel free to introduce yourselves and just say hi to all of our listeners.

Peter: Thanks, Alyson. My name is Peter Friedman. I’m the chairman of the Friedman Schuman real estate group. And our real estate practice covers not only purchases and sales, but leasing as well. Commercial leasing is one of our specialties. I have handled not only dozens, but perhaps hundreds of commercial lease transactions and related matters, including borrowings and zoning. So, by virtue of being involved in all of those related disciplines, we have a very comprehensive approach to commercial leasing.

Alyson: That’s wonderful.

Lee: Hi, I’m Lee Mogavero. I primarily practice in bankruptcy and solvency restructuring creditor’s rights. I guess if that were my major, my minor would be real estate. And also, of course, in the course of my practice in insolvency, I’ve been involved in a substantial number of commercial real estate loan workouts, foreclosures, restructures. So, in that context, I’ve had the opportunity to become pretty familiar with commercial leasing. Also, Peter and I have done some work together. We recently appeared in court together and have done some seminars as well. So, it’s nice to get the opportunity to chat with you and discuss some of what we feel is important in the context of a commercial lease, this time around from the landlord’s perspective. And thinking the typical landlord we might represent may be a owner of a small shopping center, owner of a small office building, an industrial property even. So, we would be negotiating on their behalf with a prospective tenant and looking at what we need to put in that lease in order to best advocate for our client and protect the landlord’s rights down the line through the course of the lease term.

Alyson: That’s great. And I love that you kind of hinted that we’re going to be doing a part two to this little mini-series where we will be sharing some really important provisions for tenants as well. So, our listeners can definitely stay tuned for that. But before we start talking about tenants, we are going to dive into landlords and what these provisions look like. I know that we discussed this prior to the episode and you guys made a list of some of the top provisions that all landlords should know about. And so, we are going to start off with rent. So, what would you two like to share to our listeners and even a landlord who might be in the midst of getting ready to create a commercial lease and get some tenants in their building? What would you guys want to share about rent?

Peter: Well, Alyson, there are two basic types of rental arrangements. One would be a gross lease. One would be a net lease. And there are variations under each of those categories. A gross lease requires a tenant to pay a fixed amount of rent, and there’s no extras. A net lease requires the tenant to pay rent, plus extras which may include taxes or insurance. Taxes, insurance…

Lee: Utilities maybe, some other kind of upkeep costs, common area maintenance.

Peter: Common area maintenance. And in some leases, the cost increases are passed along based upon a base year. So, the tenant would only pay increases in taxes or increases in common area expenses. So, we find that office tenants, you know, in the suburban setting pay gross rent, sometimes some of the expenses. And in the retail world it’s more of rent plus plus.

Lee: Right. If you’re the landlord to the extent you can, you want the cost passed on to the tenant. The tenant on the other hand is gonna want the assurance of a flat number every month so that they know that’s what they owed. But since we’re representing the landlord here, we wanna make certain that the landlord doesn’t have to absorb any of these costs unnecessarily. So, if we can negotiate a provision in the lease that provides that the tenant is gonna pay those costs, not the landlord. We’ve gotten something good done for our client because going forward, he’s not going to be on the hook should things like rent increase, utility costs increase, et cetera.

Alyson: Yeah, absolutely. And those are definitely all things I would say to consider while you are creating a lease agreement and just making sure that you’re kind of covering all of your bases in that sense. Did you guys want to touch on rent increases a little bit more in depth at all or go into the net net net.

Lee: Well, as far as the rent increases go, and if you’ve got a lease and it covers a number of years and then you’re going to say, year one, the rent is such and such, year two, the rent increases. Well, it increases how much? Prior to 2022, kind of standard 2% year. It’s pretty standard in the industry. But look, we all know what’s happened with inflation over the past, you know, years, several months, et cetera. And so, if you’re the landlord, in order to protect yourself from getting hit with inflationary costs and having to absorb those costs, you definitely want to see if you can get something a little higher than 2% built in there. And whether you can negotiate or not, to some extent, is going to depend on how much leverage you have. But if you’re negotiating from a position of strength, you certainly want to see if you can get a little more than 2% in this environment.

Alyson: Do you have a certain percentage that you would normally suggest to clients?

Peter: Well, in today’s— in today’s environment, as Lee was saying, there’s a lot of inflation. So landlords may want a CPI increase. And as we all know, CPI last year was around 8 percent. If a tenant had to pay an 8 percent increase, that would be an ouch for the tenant.

Alyson: Yeah, makes sense.

Peter: And say, okay, landlord, if you want a CPI increase, then I want to cap it at some number, let’s say 3% or 4%.

Alyson: Makes sense. Lee, do you have anything else that you would want to discuss on that topic?

Lee: No, I think that makes sense. And I do think that you’ve got to be reasonable in a negotiating posture with anybody. And you obviously, if you want to lease this property to a prospective tenant, you’re not going to be so hard lying that also it doesn’t do any good to put a stranglehold on the tenant so that they ultimately can’t pay. So that’s why when Peter said, you know, 8% increase is going to be an ouch. It’s going to be an ouch. The tenant may not sign the lease and also even if the tenant agrees at the time and signs the lease, you may be in a default situation down the line because that 8% is just, you know, not sustainable for the tenant.

Alyson: Absolutely, and I think that what you just touched on brings us really nicely into the next point, the second in our list of provisions, the second most important provision, which would be term and renewal options. So, would you both like to dive in a little bit deeper to that and what landlords should be thinking about as they are considering renewal options and term length for their tenants?

Peter: Sure. We typically see terms of five years. In the context of a retail lease, it could be five years or even longer from a landlord’s perspective. And when you’re dealing, when we’re dealing with national retailers, the term would be 10, 20 years.

Alyson: Wow, that’s a lot of time.

Peter: So…that’s what landlords require, and in a lot of cases it makes sense for tenants, if they can lock in a space and lock in perhaps a better rental if they commit to a longer term.

Alyson: Okay. Very interesting.

Lee: And if you’re the landlord, you’re also going to want sufficient notice provisions in if the tenant is not going to re-up. You want something in there that gives you a long enough period of time and requires sufficient notice so that you can put someone else in that space. And part of why retail leases are so long is because those spaces are very much tailored toward that retail tenant. And so, you want to keep that tenant in as long as possible, and you also need sufficient lead time to get someone else in there. Office space, not as custom-made for the office tenant. You have an office whether it’s accounting firm, a law firm, an architecture firm, whatever, pretty much the same sort of plain vanilla space, at least, right? Whereas, if you’re talking about retail, you may have some very specific fit out for that particular tenant that you want to make sure you get the long enough term to justify that fit out.

Alyson: That’s really interesting. I’m learning a lot from this conversation. I will tell you that I had never really thought of the difference between, you know, lease lanes between retail and office spaces, but that completely makes sense. So, definitely something for landlords to consider and even somebody who’s thinking about maybe wanting to get into that space and become a landlord and start investing in commercial properties, definitely something to consider and to know too.

Lee: Sure. Think about it. Next time you’re in, even say a restaurant, look around and see how much of that is tailored just toward that specific restaurant. That’s true. Maybe a national chain toward that brand. And for a landlord to invest time and money and commitment to all of that lease term, they’re going to want to know that it’s not five years, it’s something beyond that.

Alyson: Yeah, that makes a lot of sense. So, as we keep going through this list, let’s touch on the third most important provision, and that is maintenance and repair responsibility. What should a landlord know about this or be aware about in terms of maintenance and repair responsibility with commercial leases?

Peter: So most commercial landlords take on responsibility for repairs and maintenance.

Alyson: Okay.

Peter: And I think it’s particularly in a building with multiple tenants, it’s easier for the to take care of the routine or daily cleanup. That would be for each individual tenant to hire a company to do what might be a 15 or 20 minute job. Same thing with the building systems. The landlord would want to control who’s going into the utility rooms and who’s dealing with the HVAC equipment, and they would not want the tenant to mess around with that. Retail is different.

Lee: Yeah, I mean, that’s something where you don’t have, you know, the office building with the number of tenants, where you have the retail tenant has control of their space, and…look, a store owner is going to have their cleanup crews come in every day. It’s going to depend on the nature of their business, how often someone needs to come in, what’s involved in that maintenance. So that’s going to be more on a tenant-by-tenant basis, rather than a building where, you know, we see the cleanup crew comes in at the end of the day, and we see them going from office to office, and the landlord has some vested interest in making certain that that’s done consistently through the entire office building, and especially something like the HVAC or the electric or the one keep control of that. They’re not going to let the tenant assume that responsibility because that is something that the landlord wants to make sure is done properly according to professional standards, etc.

Alyson: Are there any rare cases where you have seen that a landlord, a commercial landlord, hasn’t wanted to take on that responsibility or are there any kind of rare situations where that does happen or typically not?

Peter: Well, in the retail setting, the answer is yes. Tenants do take care of HVAC equipment. And sometimes, in the context of a longer-term lease, the tenant is responsible not only to repair the HVAC equipment but replace it.

Alyson: Oh wow.

Peter: So, in that case, the tenant will work with the landlord’s roofing contractor to make sure in the cases of HVAC equipment on the roof, they don’t mess up the warranty. But yes, tenants will take care of their own HVAC, and a lot of retail landlords prefer that.

Alyson: Okay.

Lee: And the other thing you have in retail, where you have large shopping center, mall type of situation, where you have common area maintenance, CAM, where as part of the lease expense, the tenant is required to pay a portion of the common area maintenance charges. So, the cost is dispersed among the various tenants, usually proportional to the amount of space that they’ve leased. And so, the landlord would handle all of that, but that’s a cost that gets passed on to the tenant.

Alyson: Very interesting. Is there anything else that you, either of you, would like to add to that before we move on to number five?

Peter: I think we’re ready for number five.

Alyson: Perfect. So lastly, in our list of most important provisions is the security deposit and personal guarantee. Can you both explain a little bit more about what that looks like and different things that commercial landlords should consider when they’re adding this into their lease?

Peter: So, I’ll talk about the security deposits. is a cash payment that the landlord holds as security for the tenant’s obligations during the term of the lease. Security deposits can range from one month of security to, I’ve seen, six months of security.

Alyson: Okay.

Peter: They are typically held in a non-interest-bearing account. Okay. And if there is a breach by the tenant, the lease typically provides the landlord would have the right to apply the security deposit to cure the default.

Alyson: Okay.

Peter: And the lease may also provide that if the landlord applies a portion of the security deposit, that the tenant is required to replenish that so that the landlord always has a certain amount of security deposit on hand.

Alyson: Wow. That’s interesting. I really had no idea.

Lee: Makes sense, because if not, if it’s depleted, you’ve kind of eliminated your ability to recoup the cost of repair.

Alyson: That’s super interesting. I had no idea. I’m learning so many new things from this episode.

Peter: And then at the end of the lease, assuming the tenant has complied, the landlord has duty to return security deposit to the tenant.

Alyson: Yeah.

Lee: And sometimes the least is the least—I think I’ve seen the least provisions that actually provide a timeframe for doing that, right, or within so many days, months, whatever, of termination at the least. Yeah.

Peter: Typically, it’s 30 days.

Lee: That’s what I thought. So— Personal guarantee. Okay. So, in our hypothetical world here, we’ve been kind of saying, well, we’re representing a medical practice, a small law firm, small mom-and-pop store and rather the tenant leasing to those, the landlord leasing to those tenants. I’m sorry, I misspoke. The professional practice, the mom-and-pop store, may be formed as an entity, a limited partnership, an LLC, a corporation, and may have very limited assets other than the business assets that could be, say, a medical practice, accounts receivable, the mom-and-pop store, the little bit of inventory and the registers and that kind of thing. Not a lot to go after if the tenant defaults. We’ll ask for a personal guarantee from the equity holders in the small tenant, so, from the doctors in the medical practice, from the mom and pop in the mom-and-pop store. So—excuse me. Personal guarantee says, if the tenant defaults, I will be responsible for the obligations of the tenant under the lease. So, how does that happen then? The tenant defaults. Mom and Pop. How do you get Mom and Pop to pay? Well, the most important provision you can probably get in that personal guarantee is a warrant of attorney to confess judgment. Legal term, really archaic, but a very significant tool if you’re the landlord. Because that enables you to immediately go into court and get a judgment against the guarantor. And then that judgment can be satisfied against bank account assets, personal property assets, stock, bonds.

Alyson: Wow.

Lee: Anything that that particular guarantee to our owns. So, you as the landlord are going to say, I want a personal guarantee from mom and pop, and I want one with a warrant of attorney to confess judgment. Now, you’re probably going to get pushed back on that, but that’s a hill worth dying on.

Alyson: Okay.

Lee: Because it really is—if all goes bad, that may be your leverage to recoup your losses. So—

Alyson: That’s great to know.

Peter: Let me just add, sometimes we will see a hybrid. So, the landlord will ask for three or six months of security, the tenant will say no. So, the parties will negotiate for a smaller cash security deposit, plus the tenant’s principal will deliver a personal guarantee. And that’s how we get home in that type of negotiation.

Alyson: Okay.

Lee: Right, because on your wish list, if you’re the landlord, you want to win on every one of these issues.

Alyson: Right.

Lee: You want the rent, the term, the maintenance, the security deposit, personal guarantee. But unless you really have all of the leverage, you’re not going to. It’s a give and take. So, the give and take might be, like what Peter said, smaller security deposit, but a personal guarantee. Or maybe if they can put up the substantial security deposit, you get some pushback and they say, well, Mr. Landlord, you got all this money that you’re holding. I don’t think that I, as the principal of the tenant, should have to guarantee that obligation as well. So, you know, kind of give and take, and you sort of pick your battles. And again, it comes back to how much you really want to lease the property to that tenant. What your situation is, the property, whatever, how desirable it is, and whether you people lined up to rent that space or not.

Alyson: I’m sure that makes a big difference as well. Well, this was great, Lee and Peter. I know I already mentioned it, but I learned a lot just from this conversation, and I’m sure that everybody who tuned in and listened did as well. Before we wrap up, is there anything else that either of you would like to add about important provisions that commercial landlords should be aware of, or anything else that you just wanna add about commercial property in general, feel free to add anything else before we wrap it up.

Peter: And in a lot of situations, commercial leases can be voluminous. So, in representing landlords, that’s generally helpful, because the provisions of the lease are typically pro-landlord. But both landlords and tenants, we’ll talk about tenants later, should, you know, pay careful attention to not only the terms that we talked about today, whether it’s rent or term or who takes care of the HVAC or the personal guarantee, but there are other provisions that require some care and understanding and some negotiation.

Lee: Mm-hmm. Read, define, print.

Alyson: That’s definitely a great tip for sure. Well, thank you both again so much for joining The Legal Way podcast today. I’m very excited for part two of this and we will be back very soon.

Lee: Thank you.

 

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