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I met with an executive officer of a Biotechnology company on Thursday. They are expanding operations and performing staffing projections for the next 3 three years. We found out that their current space is not adequate and that they should be in about double the amount of space than they are currently in. After speaking at length with them and touring the current facilities, it was apparent that there were some key elements of leasing that they were not considering. We’ve noticed on several occasions after speaking with decision makers, that they don’t understand some major components when it comes to leasing office, industrial, or biotech space and this can have economic ramifications later on.
So while working on a “lease abstract” for them this weekend, I thought I’d write about the high points of what one should know when it comes to corporate leases.
Gross vs. NNN (triple net) vs. Full Service – I wrote a short blurb on this previously, but thought that I would touch on it again, since many don’t understand the differences and how it can affect expenses. A gross lease means that that is the total amount you pay monthly to the landlord, excluding utilities. This is typically all inclusive; however, sometimes their may be CAM charges on top of the gross amount. NNN (triple net) leases mean that there is a base rent, and then shared expenses on top of that amount. Typically these additional expenses include a prorata share of insurance, maintenance and property tax costs. There is another type of lease called a “modified net” which can include any combination of the above. Full Service is a designation usually used in office leasing and is similar to a gross lease, however usually includes janitorial costs as well.
It’s important to understand what your total liability is annually and not be surprised by pass through costs that you are obligated to pay through the terms of your lease.
CAM (Common Area Maintenance) – Usually charged on a prorata share, this is an expense passed through to the tenant of any common areas shared by the tenants in a property. This can include lobbies, conference rooms, landscaping of premises, parking lots, janitorial, and management fees.
Tenant Improvements (TI’s)– This is work performed on the space prior to, or during, occupancy to make it usable for the tenant. These can be paid either by the landlord or by the tenant or both, depending upon the agreement. You just need to understand that the more the landlord has to put into TI’s upfront, the more they are typically going to want in rent, to recoup those costs. It’s important to evaluate the different scenarios to see what is most beneficial to your organization and what your projections are. If you have cash and can afford the TI’s, it can sometimes help on rent and actually save you money in the long run on the term of the lease.
Lease options- This refers to the ability to extend your lease after the initial rental period expires. You can have a 5-year lease with a 2-year option; meaning that at the end of your initial 5 years, you have the option to continue under the pre-arranged terms of the lease for another 2 years. Options can be beneficial to the tenant, because you can control the property and determine your own fate in the space. Remember that there is usually a given window of time where you need to express your interest, in writing, to the landlord to let them know you would like to exercise your option. If you let this window pass you by, you may have to renegotiate your terms all over again.
Right of First Refusal- This gives you the opportunity to acquire adjacent spaces should they come available and should you need more room. The owner can offer you the space at the same terms, or may increase or decrease the amount of rent on that space, depending on the market at that time. The owner is usually not required to offer you the same terms on this new space as on your current space, unless those terms were prearranged in your lease.
Annual Increases- Annual increases hedge against inflation and rising costs to the owner. There are a variety of ways to increase the annual costs and can include standard percentage increases to the base rent or tiered increases. Sometimes with startups or growing businesses, owners will forego increases for the first year or two, and then have higher increases in subsequent years. In retail and manufacturing, annual increases can be tied to the CPI (Consumer Price Index) report published annually. Be aware that it’s just as important to the owner that your business succeed as it is to you. They want you make money and pay your rent on time, so make sure you work with a professional to ensure you come to terms with the landlord that benefits your business.
Of course, there are many other factors and moving parts to a lease, but these are some of the major components that can directly affect the bottom line. Since rent can be one of the major expenses of any business, it’s important to understand and consult with an industry professional on how you can better optimize the terms of the lease and increase profitability now and towards the end of your lease.