Time for Lease Review or Renewal- Don’t Forget your Lease!

Fall is a good time to review business operations and start the planning process for the upcoming year. For many small businesses, outside of their work force, the most important asset is their lease.

This is especially true for businesses that depend on their building facilities for their success. Think restaurant, entertainment venues, retail and so forth. Leases should be reviewed annually to be sure all lease terms are being followed and to be aware of the end date of the term of the lease. Many leases have options to renew that must be exercised many months prior to the end of the lease date. If you do not exercise your lease renewal within the time period set out in the Lease and in the manner specified in the Lease, you can lose your right to renew your lease.

If you want to renew but want a different rent or other terms, you need to approach your landlord well in advance of the renewal notice time period to see if the lease can be renegotiated. For example, if the lease end date is December 31 and renewal requires notice in writing to the landlord six months prior (June 30), then you should be approaching your landlord in January of that year to have enough time to see if you can renegotiate by the renewal date and if you cannot, you at least have the ability to renew the lease as is.

Renewal options often have a number of different ways to calculate rent for the new lease for the renewal term. Many leases simply have a specific per square foot increase in the lease. For example, if the lease rate was $12 per square foot, the renewal rate might be $13 or some other specific amount. Alternatively, the rate can be increased by the increase in the cost of living, the CPI index, from the beginning of the lease term to the end. This, in the past, has been a fairly standard way of handling lease renewal rents, but with the surge in inflation following the pandemic, this method leads to an exorbitant increase in the rent for the renewal term.  The final alternative to a renewal rent is called “market rent,” which simply means that your rent will increase to what the market rent is for similar facilities.  If this is the case, you get a proposed rent increase from the landlord and have the ability to disagree on the amount and, depending on the terms of the lease, submit to a form of arbitration or mediation to determine what the market rate is. In some cases, the lease terms will simply state that if you disagree with the market rent, then you do not have the opportunity to renew.

If you decide you do not want to renew and would rather find a new facility to lease you also need to start this process well in advance of the end date of your lease. I suggest at least one year in advance of the end date. In this case, you should consider engaging a commercial real estate broker and attorney that is experienced in real estate. The broker will know the market and what facilities are available and the attorney will be able to review the proposed lease when you do find a facility and be certain that the terms are protective of your interests. Lease terms are very complicated, and one word can make a major difference.  Moreover, leases are usually prepared by landlords and their attorneys, and the terms are almost universally favorable to landlords.  You need experienced professionals to even the odds and protect your interests.

There are several different types of leases. Some leases are considered “triple net” in which the tenant pays a basic rent and then pays all taxes, insurance, and maintenance costs of the facility, either by direct payment or by reimbursing the landlord for those costs. Another type of lease is a “full-service lease” in which the landlord provides all of the services, and the tenant pays base rent and then an additional rent to cover all of those services which can increase each year based on the increase in the cost of providing those services. These provisions are quite complicated, and you need to watch carefully as to what is included in the services and be sure that you have a right to audit the landlord’s expense statement and be able to verify that the costs are accurate and appropriate. There are many hybrid leases that have a portion of both of the terms in which the landlord provides some services, but the tenant is required to provide others. In these types of leases often the tenant is required to pay for all maintenance to the interior of the premises and the landlord is responsible for exterior maintenance and major repairs.

As you can see, the complexities of leases are apparent and daunting.  This most important asset of your business must be carefully monitored and preserved so that your business success is not derailed by loss of facilities or inappropriate or excessive rent and other lease terms. Have you reviewed your lease recently?

Michael J. McKitrick

Posted by Attorney Michael J. McKitrick. With over 40 years of hands-on commercial litigation and transactional law experience, McKitrick’s practice encompasses business and transactional advice, commercial real estate matters, and regulatory and practice management guidance for health care professionals. Most of his clients are in the medical, financial services, and manufacturing sectors. https://www.dannamckitrick.com/michael-j-mckitrick/

Article posted in October 2024 edition of Small Business Monthly