Commercial Property Executive, August 20, 2014
I have been doing a lot of flying recently. So I thought I would address a question I usually get asked: “Why are office leases so long, even for a short-term lease?” Companies usually equate a long lease with high legal fees, figuring that if a lease is 50 pages or so, some lawyer is going to charge for several hours just to read the lease, and then the company assumes the negotiation of the lease will drag on, given that there is “so much in it.” I generally represent both landlords and tenants, so I see it from both sides.
Why are leases so long? Simply put, in most states, absent some agreement to the contrary, the law generally protects the tenant. So a brief lease benefits the tenant (except in the retail context, where it’s the retail tenant that wants to make the lease longer to address its ability to operate free of restrictions from the landlord).
With ownership of most Class A buildings being in the hands of institutional owners (or investment funds acting as institutional owners), ownership needs to shift risk and allocate costs to the tenant so that ownership’s returns are kept steady and not subject to offsets, deductions and unanticipated costs. So all of these costs, to the extent they can be identified, are shifted to the tenant. The role of the tenant’s lawyer is to push back and allocate some of the risk and cost to the landlord.
It is a never-ending game, and, fortunately or unfortunately, the game board starts with the landlord’s form of lease, so the tenant is at a disadvantage. For most straightforward leases (general office use and under 10,000 square feet), the experienced lawyer will either know the company well or interview the company in advance and pick the business issues that are important. While the lawyer still needs to read the lease from front to back, one with experience will have seen most of it before, and the issue will be, “What is important in this occupancy?” If there are some deal points that everyone knows are important, the company is well advised to get these included in the letter of intent.
It is always important to compare apples with apples. Sophisticated companies understand the difference between buildings that bill tenants for expenses of operating the building on a direct or “net” basis” and buildings that only pass through the portion of those charges that exceed the amount incurred during a stated base year (the “gross” lease). Comparing the base rent and costs of operation between two differently structured leases is not helpful.
After years of negotiating leases, my view is that a heavy mark-up by the tenant’s lawyer is counterproductive and indicates that the building and the company’s business expectations were not properly vetted by the brokerage team before the lawyers got involved. The other common mistake is to have a New York or Chicago lawyer negotiate a lease for space in Phoenix or Los Angeles. The out-of-state lawyer has not seen the building, is unknown to the other lawyer and is basing his or her experience on their own leasing practices, not custom and practice in the city where the premises are located.
One insight is to break the lease down into three parts: (1) costs of moving in and building the premises out for occupancy, (2) strategies for getting out of the lease if the company’s business needs (or its composition) change before the end of the lease term, and (3) identifying critical operational requirements, including voice and data, utility consumption and space sharing needs during occupancy of the premises. The analogy I like to use is that commercial leases are like airlines: Figure out what you need before you make the reservation and book the flight accordingly, because changing reservations afterwards is always expensive, time consuming and risky.