The Lease Proposal document will be used by the landlord’s attorney to prepare the lease contract. Some less seasoned executives and landlords will sometimes try to move the lease proposal negotiation into the lease contract negotiation before having a lease proposal agreed to by both parties. This approach is fraught with misunderstanding and wasted time as you should not be rehashing basic business terms during the legal term discussion.
There are a few universal lease proposal sections that we’ll discuss here. As you can imagine, each lease contract section can be multiple pages long and filled with nuance, so we won’t get into more than you need to have enough understanding to ask the right questions from your team members.
Parties
The parties are the trade names or official entities for both the landlord and tenant. It can be essential to communicate here who is to be on the lease. There can be ambiguity as to whether it is the principal of the company, a newly set up corporation, a subsidiary, or a corporate parent.
Property Address
This one is self explanatory. On the odd occasion, we have had to change the property address number, letter, or suite based on preference. This is surprisingly possible and less difficult than one would expect provided that the United States Postal Service and local fire authority are on board.
Premises Size
This is the approximate size of the building in question. Some people will get caught up in the exact measurements of the building. Know that if you hired five architects to measure the building using industry standards, you are likely to get five different sizes. The basic understanding is that the building square footage is an approximation. You must rely on the fact that the space is adequate for your operations and that the total amount you are contemplating paying is reasonable. The Building Owners and Managers Association (“BOMA”) is the primary authority on square footage. They most current Standard of Measurement guidelines are from 2019 for industrial buildings and can be purchased through BOMA and SIOR.
Lease Commencement Date
This is the date that you formally take possession of the property and start paying rent. Don’t confuse this with substantial completion of construction, early occupancy or free rent. This is the one date you want to be crystal clear on. This date is equally as important for the landlord as they have to guarantee completion of construction by this date or incur penalties.
Lease Term
This is the length of time that you want to be able to utilize the property. Some people quote lease term in month or years. It is customary to have full year lease terms. It is not unheard of to split the last year into a less than full year length if it suits your business better. For example, one of my clients has found it is ideal to have all their leases expire 12/31. We literally have negotiated every single lease to have that same lease expiration date so that we do not interfere with their busiest times of the year. Landlord can empathize and will usually accommodate.
Lease Rate
The lease rate is quoted on a per square foot per month basis in Southern California, Houston and other outlier markets, and on a per square foot per year basis everywhere else. The lease rate needs to denote whether it includes or excludes the operating expenses of the property. In industrial property leasing, you only really have two choices, Triple Net (NNN) or Gross. Some people can call leases modified gross, or modified net, whereas the rent payment includes certain operating expenses, but this is not prevalent and usually unnecessarily confusing. The idea here is that every property lease needs to account for rent, property tax, insurance, and maintenance. Great negotiations result in everybody knowing who is responsible for what. Additionally, certain markets quote lease rates differently for the office portion of the space and the warehouse portion of the space. Seattle, WA is one of these markets. You will already know if you are in that market what you have. It is good to be clear on this early on in the process.
Lease Rate Adjustments / Escalations / Annual Increases
The annual increases describe how much the rent should increase each year. The general sentiment is that the base rate should adjust each year to keep up with inflation. In practice, this is subject to the supply and demand dynamics at the time of negotiation. When I started in the business in 2004, there were still instances where we would negotiate annual rent increases based on the Consumer Price Index. It averaged 2.1%. The industry standard for ten years transformed into a uniform 3%. As the market tightened in 2018, we started seeing 3%, 3.5%, 4%, and 4.5% annual increases, which had nothing to do with inflation. These escalators increased at a higher percentage to keep up with the market rent growth. When you do the math between 3% and 4.5% annual increases, you find that if you weren’t paying attention and accept the later, you are paying an extra two months of rent during the same five year period that could have been invested in your company. In Southern California industrial markets, from 2014 to 2019 the market averaged 7.5% market growth in lease rates. If you signed your five year lease in 2014 with 3% increases and the market had compounded growth of 7.5% for five years, you will be very surprised in your next lease negotiation. While hindsight is 20/20, I have found in the industrial leasing, rarely do companies commit to too long of leases.
Tenant Improvements
This is the section of the lease proposal where you describe what modifications to the property are necessary to accommodate your needs. This section defines who is to design, perform, and pay for said modifications. Tenant improvements are costly and time-consuming, yet they can have such a disproportionate effect on the success of negotiations. I devoted an entire chapter to the topic that you can reference in-depth as needed.
Security Deposit
We all know what a security deposit is. But how much is reasonable in the industrial market? The main factors are:
- Length of time the company has been in business
- Review of the company’s profit and loss and balance sheet
- Size of the landlord’s tenant improvement contribution
- Length of the lease
There are also different methods of payment and forgiveness of the security deposit when a more substantial security deposit is required. Sometimes this can be paid up in increments over months and credited back to the tenant over years.
Depending on the circumstances, we start customizing lease proposals to tailor them to fit different needs, properties, and situations. Some of the most common customizations are as follows:
Early Occupancy
This represents the time that you can use to move into the property, set up furniture, and install IT, equipment, and racking, before you start paying rent. Early occupancy can also be a practical concession to start the lease on the 1st of the month. The key differentiator between early occupancy and free rent is that in early occupancy you are granted non-exclusive possession of the space. That means that the landlord retains partial possession during this time, usually for completion of tenant improvements. Landlord don’t want you to be fully operational at this point in most cases as a result.
Rental Abatement
This is more commonly called free rent. While the concept is simple, its application is nuanced. Most people think of free rent to set up their new building before they start paying for it, which is easily confused with Early Occupancy described above. Free rent though is a concession. The landlord only gives free rent if it is needed to attract the tenant. Most of the time we want free rent to be given at the start of the lease because it will offset substantial cash outlays and capital investments in furniture, construction, equipment, etc. This overlap helps smooth out monthly cash flow.
You must recognize that free rent is the loss of cash flow to the landlord. As such, sometimes, the landlord is willing to give more free rent if spread throughout the lease term. This can take the form of one month free at the anniversary of each year, being in month 1, 13, and 25 for example.
Most landlords will add a month lease term to the total lease length for every month they give free. We reference this approach by saying that the landlord is giving free rent “inside the lease term” or “outside the lease term.” For example, think of a five-year lease with two months of free rent. When free rent occurs inside the lease term, a 60-month term results in 2 months free and 58 months paid after that. When free rent occurs outside the lease term, a 60-month lease becomes a 62-month lease whereby the first two months are free, and 60 months paid after that. Each situation and market dynamic will change how to approach free rent.
Operating Expense Abatement
Most industrial leases are triple net leases subject to the tenant paying their proportionate share of property tax, insurance, and common area maintenance. If you can negotiate free rent, does that mean that you pay nothing to the landlord during that time? Or do you still need to pay the operating expenses? There have been countless misunderstandings and mismanaged expectations over this nuance. It is assumed by the real estate community that you pay the operating expenses during any free rent period unless explicitly stated otherwise. It is assumed by the uninitiated that free rent means free rent and free operating expenses. Whether you can negotiate an operating expenses abatement is another matter altogether and possible when arranged thoughtfully.
Deferred Maintenance / Base Building Condition
Many leases will have a section that states that the building will be delivered to the tenant with all of the building operating systems in proper working order. In practice, I have found that it is helpful to call out all specific building systems that are deficient. You don’t want to tell the landlord that their building is in terrible shape because it shames the landlord and doesn’t provide them an opportunity to save face. You likely wouldn’t be negotiating on it in the first place if it was in such bad shape. Overly aggressive tenant rep only brokers and some tightly wound executives can sometimes want to take this path but they do not make friends in the process. It bears mention that how you call out deferred maintenance should be handled delicately.
First, you want to do this early in the process so that the landlord knows that they must fix these neglected items. Second, you want to make sure that the landlord doesn’t confuse the fixing of deficient building systems with your tenant build-out needs. You will find that sometimes the landlord will mention their future property renovation plans and then use those plans against you when you are negotiating tenant improvement allowances. It is understandable because the mechanics of working with a general contractor and making payments is the same as the landlord. Because of this, it is helpful to differentiate deferred maintenance from tenant improvements because one is for the landlord’s benefit while the is for the tenant’s interest.
Parking
Parking is a big deal in office leasing because you pay for each reserved and unreserved stall, and you pay for visitor validations in a parking structure. When leasing a warehouse, you don’t deal with this as there aren’t parking structures for warehouses. You still need to make sure that you are clear on the amount of parking that you can use when you are in a business park environment as parking can be shared and in common with other tenants. You might be able to reserve parking for your employees when it is essential to you, and as the property dynamics allow. Can you park work trucks overnight in front of the building? What about tractor-trailers? What about storing trailers in the yard? Is the yard fenced, and is it practical to fence it? Who is going to pay for it? Who is going to hire the fencing contractor? Parking and yard space have its own set of considerations, and not all business park environments, cities and municipalities allow for different parking accommodations. It is imperative to communicate your needs to the landlord upfront to figure so that they can best accommodate them.
Some people see that there is street parking available and plan on using that for their extra employees until they find out that the city won’t count that towards their allotment, or parking isn’t allowed on holiday, or the neighbor starts their shift an hour before yours and all of the spaces are already taken on a daily basis.
The purpose of the lease proposal is to be able to size up your landlord’s ability to accommodate your needs without forcing them to negotiate unnecessarily. As a result, we want the contents of our lease proposal to focused purely on fulfilling that purpose.
