In the past, I have written articles concerning residential leases. In this article, we will examine some of the issues regarding commercial leases. While commercial leasing may include large office buildings, retail stores, restaurants, theaters and other uses found in Manhattan, we will focus on the type of commercial business more common to the East End of Long Island and more proximate suburban areas.
First, we will explore a few fundamental points. A commercial lease, just like a residential lease, is a contract, but since a commercial lease covers a longer period of time than a residential, it is going to be much thicker. The typical residential lease is usually no more than three years, often times shorter, and the terms of the lease are less complex. Commercial leases of ten and fifteen years, sometimes longer, are typical. And while I take exception to the term “standard lease,” even for residential, the term would be even less applicable to commercial leases.
To gain some perspective of the commercial real estate market, let’s take a look at the development of a suburban shopping center. Many of the issues to consider are not unique to this type of endeavor. For instance, before I start investing any money, what is the market for a shopping center in the area I am contemplating? Do the demographics of the area sustain a Neiman Marcus, or would a Macy’s be more appropriate? What would be the costs of developing the shopping center, such as acquisition of the land, costs of financing, construction, insurance, taxes, marketing, and all other initial and long-term costs? What is the competition I would be up against? Unless I am confident I can rent the spaces, short-term and long-term to meet my costs and return a profit, I don’t want to start incurring costs. What if a zoning change would be required to develop the property to its highest and best use? I certainly would not want to be obligated to purchase the property should my analysis illustrate that it’s not a good investment or I couldn’t get the zoning changed. An option to buy the property from the current owner while awaiting the answers to these questions is a common solution.
One of the most important factors in the success of the venture is the attraction of the anchor tenant, the first tenant to sign a lease. It is this tenant that attracts all the others and on whose success they depend upon. Some businesses are destination points for customers, known as generative, in that they generate business for other tenants, who are not typically destination points. These other tenants are referred to as derivative, they derive their business from the generative. Because the anchor tenant is critical to the success of all the others, the developer will offer an aggressive rent to the anchor tenant, an amount lower than what might be the value of the space, and apportion the loss among all of the other tenants. The apportionment is not equal. The closer you are to the anchor tenants, the more of the loss to the developer you absorb. This leads to an important consideration for the tenant. What if the anchor tenant relocates or goes out of business? Will the tenant receive a rent reduction or be able to terminate or assign their lease and with what consequences? If the lease allows for assignment, the landlord may want to have control of who the new tenant may be. The landlord’s leases with other tenants is likely to assure them that the space will not be rented to tenants who would be in competition with them. What if Blockbuster signed a lease fifteen years ago and now they are not able to meet their rent obligations? Do they have any recourse? We would have to look to the lease.
Commercial leases are based on square footage. Some may be net leases, where the tenant pays some or all of the property taxes and expenses, or percentage leases where the rent is tied to the tenant’s profits.
What both the developer and tenants must keep in mind is that the longer the term of the lease, the more things may change that will affect their financial interests. The answer is, either have a crystal ball, or a well drafted lease that has anticipated all of these possibilities.
There are real estate brokers and attorneys who specialize in commercial leasing and should be engaged by those who intend to become involved in transactions of that sort.