Office Leases: Negotiating Key Terms in Letters of Intent

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Guest Column from Ballard Spahr's Leasing Group

Editor's Note: Mortgage banking companies are often tenants leasing or subleasing office space, usually in multiple locations. In this edition of Mortgage Banking Update, we are introducing the first in a series of articles by attorneys in Ballard Spahr's Leasing Group that will explain the commercial leasing process and explore issues such as how a lease affects ongoing operations, how to plan for changing needs, the impact of foreclosure and bankruptcy, and how to get out of a lease. In this article, Alicia B. Clark, an attorney in the firm's Denver office, discusses the benefits of negotiating key lease terms in a letter of intent.

There are many different reasons a business may need a new office lease, including the upcoming expiration of its current lease, the desire to increase or decrease the size of its existing space, or the need to relocate or expand to a different geographic location. This article explores issues to consider in the early stages of negotiating a new lease.

Leverage

A tenant has the most leverage to negotiate favorable lease terms with an existing or new landlord when there is sufficient time built into the leasing process. If a tenant plans well in advance of its move-in or expiration date, it will have the best leasing opportunities. While it may be difficult for some tenants to focus resources on space planning needs that seem far into the future, early planning should pay off with stronger negotiating leverage and, therefore, more advantageous economic and legal terms of the lease.

Depending on the specifics of the deal, it is likely to take three to six months or longer for a tenant to negotiate a lease, build out the space, and relocate its business. Therefore, analysis on space and site needs and opportunities in the market must start well in advance of that time period―12 to 24 months before the target move date is not unreasonable.

Even a tenant who expects to renew an existing lease should gain an advantage in negotiating a renewal by starting the process early and learning what else is available in the market. A landlord that knows its tenant has viable options to move is more likely to offer competitive deal terms. Tenants who fall into the trap of thinking they will negotiate a lease extension with their existing landlord and do not leave sufficient time to move if needed may find themselves without other options or leverage to negotiate a favorable deal.

Letters of Intent

Once a tenant has narrowed its selection of spaces, which can include staying in its current premises or moving to a new location, it is often useful to negotiate the key lease terms in a non-binding letter of intent (LOI) to finalize the site selection process. Although an LOI should be non-binding, landlords will use it as the basis for preparation of the lease agreement.

A tenant will benefit from negotiating an LOI when it still has other options available and has not yet committed its time, energy, and money to a single site. In addition, negotiating a detailed LOI rather than going right to a definitive lease document often saves tenants time and money. A tenant can usually determine in the LOI process if it cannot reach agreement with a particular landlord on acceptable terms. Except for the terms that are negotiated into the LOI that are more balanced or pro-tenant, the landlord will produce a lease on its own form with landlord-favorable provisions. Negotiating key lease terms in an LOI usually results in a better initial lease document from the landlord, which will shorten the time required for the tenant's attorney to review, comment on, and negotiate the lease.

Basic Lease Terms

The LOI should set forth the basic lease terms that encompass both financial and non-monetary items. Such items include:

  • Landlord and tenant parties
  • Description/depiction of the premises to be leased, including location and size and whether premises will be re-measured after build-out
  • Lease and rent commencement dates, length of initial term, and any renewal options
  • Base rent, rent escalations, and rent during renewal terms
  • Additional rent requirements (e.g., percentage share of common area maintenance, taxes and insurance costs, separately charged utilities, and any caps on increases in controllable costs)
  • Security deposit and guarantor requirements
  • Free or discounted rent periods and scope (e.g., reduction of both base rent and additional rent)
  • Improvements to premises and landlord allowances (including for moving costs, tenant furniture, fixtures and equipment, and permitted rent reductions for unused money)

Additional Key Terms

The LOI also should address other terms that provide flexibility to the tenant over the lease term, deal with tenant-specific requirements, and otherwise are important to the tenant.

There are several ways to provide flexibility to the tenant, including the right to expand the premises in the event of future growth, give back space in the event of contraction, or terminate the lease early. The LOI should contain a right of first offer or right of first refusal for contiguous or other space in the building if it is available in order to address expansion potential. If a right to contract the leased premises or terminate the lease is important to a tenant, the LOI should specify the timing issues and any payments to the landlord upon exercise of these rights (e.g., reimbursement for unamortized leasing costs and termination fees). The LOI may also include the circumstances in which the tenant may assign the lease or sublease the premises without the landlord's consent and specific parameters for the landlord to consider when its consent is required.

The LOI may cover any other tenant-specific requirements, such as parking rights (and costs, if applicable), signage, permitted hazardous materials usage (e.g., in connection with a back-up generator), or a waiver of any landlord liens on tenant's equipment and property in the leased premises. The LOI should be tailored to the specific business needs of each tenant.

The early stages of a lease negotiation often provide the best opportunity for a tenant to negotiate beneficial lease terms. A suitably detailed LOI is an excellent tool for a tenant to confirm the key lease terms before committing to a specific space.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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