The economic downturn has had an impact on how leases for commercial properties are negotiated in Santa Barbara County. Prior to the downturn, demand for commercial space was robust. Landlords insisted on using their own form leases and made very few concessions to prospective tenants. The decline in demand for commercial space has changed this dynamic. Now landlords seem to be happy just to have a prospective tenant and are making make significant concessions to finalize a lease. While most of these concessions are business considerations such as lower base rent or a tenant improvement allowance, many of the concessions are legal in nature and shift some of the risks historically absorbed by the tenant, to the landlord.
The following is a summary of some of just a few of the concessions we are seeing landlords make with respect to the legal terms of their lease and the implications of each. Under the heading “Prior Standard” I state what we historically saw as the industry standard prior to the economic downturn and under the heading “Current Trend,” I state what we now tend to see as the standard in lease negotiations. Finally, under the heading “Watch-Out” I highlight the implications of the lease changes.
Tenant Improvement Allowance
Prior Standard: Landlords in Santa Barbara County had offered a tenant improvement allowance only to long term tenants for specific improvements to the property. The allowance was generally reimbursed only after lien releases were provided by the tenant’s contractor and only for capital improvements.
Current Trend: Landlords are now giving tenants a rent credit or allowance which the tenant can use for non-capital items (e.g. carpet, paint, even furniture, etc.) to ready the premises for its occupancy. Landlords tend to avoid adding conditions to the allowance as they previously did as they do not want to scare the tenant away.
Watch-Out: Landlords are often anxious to get the tenant in the premises and assume the general terms in the letter of intent are sufficient to serve as the agreement between the parties as to what the funds can be used for and when they will be paid. However, disputes frequently arise in the first few months of the lease as both parties have a different understanding of the terms regarding the allowance. Also, if the allowance can be used for personal property such as furnishings, the lease should specify whether the tenant or the landlord owns the items.
Prior Standard: The lease used by most landlords provided that the landlord had up to one year to complete any “landlord work” and deliver the premises to the Tenant After a year, the Tenant’s sole remedy if the premises had not been delivered was termination of the lease.
Current Trend: Tenants want a firm commitment on a delivery date and liquidated damages or rent credits (e.g. 2 free days for every one day of delay) if that delivery is delayed.
Watch-Out: Landlords need to be sure they can complete the work they commit to provide well within the date that is specified in the lease. Frequently landlords are signing leases with just a general description of the work they are required to perform. As they are performing the work, tenants often request additional changes which can delay the final delivery date. Make sure the lease language carves out exceptions for landlord’s liability when the delay is not within landlord’s control.
Prior Standard: Many landlords use the language from the AIR Commercial Lease form which obligates the tenant to pay its share of CAM expense without limitation and contains a very broad definition of what expenses can be charged as CAM expense. There were standard exceptions that landlords often accepted but they rarely changed the basic concept that the tenants had to pay for all operating expenses associated with the property.
Current trend: Landlords are increasingly agreeing to limit CAMs so they do not increase over a certain percent every year and exclude items which traditionally have been charged to the tenant as CAM expense.
Watch-out: Is the cap on CAMs cumulative or annual? It makes a big difference. Also, landlords need to carve-out of the cap, expenses that are outside of its control (e.g. insurance, taxes, insurance deductibles for casualty, refurbishments, etc.) that are ordinary expenses that should be paid by the tenant in a triple net lease but are excluded with the language that tenants propose for the lease.
Prior Standard: Any assignments of the lease required the prior written consent of the Landlord which the landlord could withhold if the assignment increased the risk of a tenant default.
Current Trend: Tenants want the flexibility to assign the lease without the landlord’s consent in connection with an assignment by operation of law (a merger or acquisition) or to an affiliate.
Watch-out: Landlord’s should make sure their lease language requires the tenant to provide notice of the assignment and confirmation that the assignee has sufficient assets and financial standing to fulfill its obligations under the lease and/or that the assignor/tenant remains liable on the lease. Also, the tenant should be required to pay the landlord’s legal fees in reviewing the assignment. A Landlord could incur thousands of dollars of fees in verifying an assignment is permitted which are not reimbursable to the landlord as no consent is required.
Prior Standard: Tenants typically indemnify landlords even for the landlord’s own negligence, the theory being that the tenant is obligated to insure against any damages it suffers while occupying the premises and the tenant’s insurance will cover the claim.
Current Trend: Tenants want the landlord to indemnify the tenant for the landlord’s negligence and landlords are often agreeing to do so.
Watch-out: Landlord’s will need to make claims on their own insurance policies to cover claims caused by their tenants. This could lead to increased administrative responsibility as well as increased premiums depending on the number and type of claims.
In conclusion, landlords of commercial properties occupied under a triple net lease need to be careful when making concessions to their standard form leases. The standard form leases are designed to protect landlords and ensure their lease is truly triple net and passes on all operating costs to the tenants. Even minor changes to the standard language that appears fair on its face, can significantly change the structure of the lease and force the landlord to absorb risk that was not intended. In situations where tenants have greater leverage in lease negotiations, Landlords still need to be very careful about what concessions they make.