Expert Tips For Negotiating a Lease For Your Small Business
Negotiating the terms of a lease can be stressful for any small business owner. Rent is one of the larger recurring expenses that businesses pay, and the terms and conditions of your lease will be something you’re going to have to live with for as long as it’s in force.
Fortunately, there are several areas where a small business tenant has more leverage than they might think. I spoke with Jeffrey Daniels, a seasoned commercial real estate representative in the Ottawa area, to identify where you have room to negotiate for a lease that’s flexible, favourable and suited to your business’ needs.
1. Lease term
First and foremost, the length of a lease is typically open for negotiation. Most landlords default to a five-year term, but a shorter term agreement may provide a new business with greater flexibility. One-year and two-year agreements are generally harder to come by (and often incur a rental premium), but a three- or four-year term may work best for your business.
If you are financing your leasehold improvements, however, a longer lease term of six or more years may be more desirable because it gives you more time to amortize improvement costs. A longer term also lets you lock in a lower rent if the leasing market is soft.
The vast majority of commercial space is leased via net leases. A net lease is made up of net rent (sometimes known as basic rent) and additional rent, calculated on a per square foot basis. When negotiating rent, it is important to differentiate between the two.
The additional rent is comprised of a tenant’s proportionate share of utilities, realty taxes, heating, ventilation and air conditioning (HVAC), and contribution to the common area maintenance (CAM) costs. Additional rent is largely non-negotiable, while the net rent is the landlord’s income minus any commissions or improvement costs, and is always open for negotiation.
When landlords know that they are competing for a tenant, they will often provide inducements to make it more attractive to lease space in their buildings. These inducements can include free rent periods, leasehold-improvement allowances, moving allowances and new-furniture allowances.
When you enter a new lease, there are always significant upfront expenses, from renovations to IT setup costs and moving fees. Negotiating an inducement can help you minimize some of the cash-flow challenges that exist for many businesses at the start of a new lease, and you may have considerable leverage in a soft market. Figure out what you need, and don’t be afraid to ask.
4. Leasehold improvements
It’s rare to find a space you’ll be able to move into as-is. At the very least, there will be some cosmetic changes required such as new flooring or paint. You might even need more significant changes like new walls and lighting, or updates to the kitchen or washrooms.
Once you determine the extent of work required, you need to establish who pays for what. Landlords may provide an improvement allowance, either by completing the work on your behalf or by giving you cash once you’ve completed the work. If you will be receiving a leasehold-improvement allowance, your aim during negotiations is to keep the net rent as low as possible while having the landlord pay for as much of the work as possible.
Alternatively, you may decide to pay for the required work yourself. In this scenario, you want to make sure that your rent has been discounted to reflect the fact that you will be absorbing the leasehold-improvement costs. Note, however, that landlords usually require such work to be supervised to prevent construction risks to the building – for a fee that’s generally 15% of the value of the work.
5. Right to expand and option to terminate
As a small business, it can be difficult to predict what your company is going to look like in three or five years. Negotiating expansion rights or termination rights in your lease can give you some extra flexibility. Although the wording of these rights can get complicated, what you may want to achieve is the right to lease adjacent space or other space in the building if you outgrow your current premises. Alternatively, it can be valuable to have the option to terminate your lease should you decide that you are unhappy with the location, need to expand beyond the available space in the building, or need to reduce costs.
Landlords don’t typically hand these rights over without some negotiation. Be mindful that expansion rights tend to encumber a landlord’s ability to lease space in a building, while the right to terminate greatly diminishes the landlord’s security of the rent coming from your tenancy.
The bottom line
Facing lease negotiations shouldn’t be a stressful experience for small businesses. As in all negotiations, the more you give in one area should mean the more you get in another. The key to success is knowing where you have room to negotiate, and the extent of negotiating power you have. Knowledge of the market conditions, and of similar deals in the building or vicinity done recently, will also give you significant negotiating advantage.
Have you recently negotiated a lease for your business? Share your experience or tips in the comments, below.