Condition/Warranty
The condition section will customarily state that the landlord shall deliver all building systems in the property in working order. You need to ensure that the building is in good condition. It is not always practical to inspect every facet of the property when vetting properties, so we address this in the condition section.
There is a 30-day grace period in most leases. This grace period states that the landlord will be responsible for fixing any part of the building systems that are not in proper working order when the tenant gives notice. When it comes to the HVAC system, this warranty period may be as little as 30 days up to 6 months. I’ve negotiated lease warranty periods from 1 year up to 5 years in some cases. This warranty is an item that is not usually settled in the lease proposal phase and is only really negotiated by experienced brokers and in particular circumstances.
While the lease states that it is your responsibility to inspect the property before signing a contract, I have found that tenants rarely hire professional inspectors to investigate leased properties. Most tenants rely on this clause to ensure that they will get a fully functioning building upon move in.
There are dozens of books written about commercial tenant improvements. My favorite one for executives is Mistake Free Medical Office Design and Construction by Richard Boureston. The author comes from a place of extreme knowledge but writes in a manner that is accessible to all skill levels. Even though this book focuses primarily on medical office space, 90% of the advice is relevant, as 90% of the tenant improvements needed for industrial property is office space.
Tenant Improvements
My favorite textbook on the subject is Construction Project Management: A Practical Guide to Field Construction Management by S. Keoki Sears, Glenn A. Sears, and Richard H. Clough. This book is a worthy read for team members working on multiple construction projects per year for larger companies.
There are three underlying conditions in which you will find office space within industrial buildings: as-is, shell condition, and fully renovated.
When a tenant moves out of an industrial building, the landlord has to decide whether to renovate the office before finding a new tenant. The smaller the landlord or property, the higher the likelihood that they will conserve cash and wait for a new tenant to tell the landlord what they want. That means holes in the walls, dirty carpet, worn linoleum, dirty non-ADA compliant bathrooms, and damaged ceiling tiles. In this instance, most landlords are expecting to paint and carpet the space, refurbish any parts of the office that need new surfaces, and replace damaged ceiling tiles. We call the condition of such space at turnover to the new tenant, “as-is”.
Shell condition space exists when an investor purchases an industrial building, repositions it, and puts it back out to market for lease-up. If the building has a significant office space component, the investor will demo all of the existing functionally obsolescent office, replace the ceiling and lighting components, repair and paint all of the interior walls between the windows, and leave the floor as raw concrete. When you walk into the building, all you see is one clean, white, wide-open space. Some people will call this vanilla shell. An investor will then budget for an office build-out. This budget is already allocated within its acquisition pro forma to provide a basic layout for a new company. This process allows the tenant to see a clean slate, envision themselves within the building, work with the landlord’s architect to design an ideal office layout, and then have the landlord build out the office space using the allocated tenant improvement allowance.
Fully renovated office space usually exists with institutional landlords, with warehouses with less than 10,000 SF of office. The reason this is suited for institutional landlords is that they see their spaces as a direct reflection on the company, and they want their spaces to lease for the highest lease rates possible. The landlord takes the creative design component out of the leasing process by having the space renovated and ready to lease. Believe it or not, 70% of executives have a hard time trusting that an architect and contractor can turn what office space they see in front of them into the ideal new office space of their company’s future. If an executive has not lived through a commercial construction renovation before, they usually will find it difficult to imagine. Landlords fine a fully renovated space makes it easy for prospective tenants to see the space and say, “yes, that works, we’ll take it.”
A note on office renovations. Landlords used to wait to put flooring in until the tenant picked out their type and color of the carpet. This process was widespread as some sole proprietors have specific tastes or company colors. Interior design has become so sophisticated that it has become more of an asset for the landlord to hire an architect to spec out all or part of the office. Modern building standard finishes are becoming higher end than executives would choose; landlords are using this as a competitive advantage. For example, many are installing luxury vinyl tile throughout common areas or polishing the concrete instead of standard flooring.
It is essential to make sure that if you are going to modify the current office space to fit your company, you are very specific about what you want, who is going to pay for it, who is going to build it, and by when. As construction is one of the most natural places where landlords and tenants have misaligned expectations, it bears repeating.
Guarantor
Guaranty’s come in different shapes and sizes. The general premise is that if the entity that you want on the lease document is new, or if the size of the obligation you are taking on is large, then the landlord will look for an additional guarantor. The guarantor is a separate entity that also agrees to take on the obligation of the lease if the original lease signatory isn’t able. The concept is the same as a co-borrower or a co-signer on loan.
The first guarantor we encounter is the personal guarantee, and we see that with start-ups and sole proprietors. You’ll hear it referred to as the dreaded “PG”. Some new ventures have the lease in the name of the sole proprietor’s company and then guaranteed by the person who owns the company. Most landlords like things simple and will likely just put the lease in the person’s name until the point at which the tenant has fulfilled the lease obligation, and then the next lease can be in the company’s name. Usually, the time it takes to shift the lease document from the founder to the company is within the first three years.
Do mature companies need guarantors? They do in many cases. Business growth isn’t limited to the physical size of their building. Sometimes they grow by territory and geographic markets. As a business starts operating in multiple cities, states, and countries, they start spending more time and resources structuring their legal entities. We find those mature companies need to guarantee leases for newly opened locations, for exceptionally large warehouses and when asking for significant tenant improvement allowances from landlords.
Most lease forms state that if the parent company sells the subsidiary, that parent company is no longer obligated to guarantee the lease. Conceptually this makes sense as a parent company should not have to continue to secure the lease of a company that it no longer owns. On the other hand, you will find that the landlord would want more protection than just the local branch. You’ll find that custom-drawn legal documents don’t have this boilerplate release language in them. But can the landlord try to dictate that the parent company has to assign the guarantee to the new parent company? I have found that we can usually negotiate so that the parent company never has to guarantee the lease in the first place.
Change your mind set on guarantees to think about what you can and should exclude from them. Sometimes we will negotiate the tenant improvement expenses out of a guarantee. Other times, we will have the guarantee expire before the lease expires. We make sure that there is a language that the officers of the company are not personally guaranteeing the lease even if the parent company is.
