Originally created 03/28/04

Commercial real estate practices can be a big surprise



NEW YORK -- For many small business owners, signing a commercial real estate lease for the first time can be one of those moments best described as a rude awakening.

"People are used to being residential renters, and they make the assumption that the commercial renting situation is similar. It is diametrically different, as different as night and day," said Janet Portman, an attorney and co-author of "Leasing Space for Your Small Business."

While many states have laws that protect residential renters, commercial leases are generally governed by market forces, Portman said. That means just about every part of a lease is up for negotiation, and the health of the local commercial real estate market will dictate whether the landlord or the small business has the greater bargaining power.

"People should understand that when they make the decision to take space, there are hundreds of decisions that are part of the process," said J. Michael Dow, president and CEO of CRESA Partners, a New York-based real estate advisory firm. He noted that in some cases, commercial leases can be more than 100 pages long.

It's probably safest to get advice from an attorney or a real estate professional, whether or not you've ever signed a commercial lease before, as you start the process. It's also a good idea to familiarize yourself with the way commercial real estate works.

Dow noted that one of the most fundamental differences between commercial and residential real estate is that a residential tenant generally has the right to remain on the premises when a lease ends, but there is no such automatic right with a commercial lease. Unless you have negotiated a new lease for your company, you'll have to leave when it expires or end up paying a huge penalty - often twice your rent - to "hold over," Dow said.

"You would be wise to start thinking about renewing it 12 months before the expiration so you can carry out negotiations without any pressure," Dow said. That way, if you can't agree on the terms of a new lease, you'll have time to find new space.

Another major difference between residential and commercial renting has to do with how much you pay over the life of the lease.

With a residence, the rent is usually set for the entire lease, or for each year in the lease. In some cities, landlords may be able to pass along costs like higher fuel expenses to tenants, but such increases are limited.

There are similar commercial leases, known as gross leases, which allow for rent increases at specified points during the term. But another very common type of lease, the net lease, requires a tenant to pay some of the landlord's overhead, such as insurance, taxes and upkeep of the building.

Portman noted that rents can fluctuate along with those costs, making it more critical to budget for likely increases.

You can try to negotiate which expenses you're willing to pay, but again, your bargaining power can turn on whether you're in a tight market. If you really want the space and other prospective tenants are waiting in line, you'll probably have to agree to the landlord's demands.

This might sound like an uneven deal, but Portman said it isn't necessarily a negative. If landlords are unable to pass along their costs, they might not be able to maintain the building and it can deteriorate.

"If one of you goes down the drain, the other one does too," she said.

Portman said a commercial landlord and tenant should operate as business partners, not adversaries. She noted that a smart landlord will accommodate a commercial tenant who is going through a difficult period.

"In the end, he's better off, because he's had a stable tenant," she said.

Commercial leases often run much longer than residential leases - some companies take space for as much as 20 years. With such a long-term commitment, negotiators have to be careful.

But sometimes a business needs space right away. Dow's suggestion is to consider what are known as ready-made offices - a room or a suite of rooms that can be rented by the day, week or month, and that often provide secretarial services and a conference space that can be rented by the hour.

Describing such offices as "plug and play," Dow said they are expensive. "But it's worth it for the first six months while you figure out where you really want to be."