Often a professional will purchase an office building with the intent to sublet a majority of the space to other professionals. There are a few considerations you should take into account.
Potential Sublease Negotiation Issues:
Ability of Tenant to Sublet or Assign the Lease
Tenant will want flexibility to sublet the space but the owner will want to maintain control over the type of business that is in the space. The owner will therefore want to include a clause requiring the owner’s approval of any subtenant or assignee.
Tenant could either pay a percentage of operating expenses or a fixed rate on top of rent. Tenant may want some things to be excluded as well as have a cap on total costs. Owner will want to make sure that the actual costs and expenses included in maintaining the buildings are properly allocated.
Maintenance, Repair and Replacement Obligations
Owner ordinarily retains responsibility for the maintenance of the roof, foundation, exterior walls, structural elements, parking, and other common areas. Therefore, the owner will want to have a plan to ensure ability to cover these costs.
Tenant may request a provision in the lease that would allow the tenant to not pay rent if a specified percentage of the space/certain tenant is no longer leasing. For the owner, such a clause could have a domino effect severely hampering rental income.
Signage location and size should be negotiated prior to execution of the lease to prevent potential issues.
Tenant will probably want an exclusive use provision providing that the tenant will be the only party in the building to conduct the certain kind of business that the tenant conducts. Owner will want to define the exclusive use right very tightly so as not to inadvertently exclude unintended potential tenants.
A long lease will provide financial stability but on the other hand a short lease may be beneficial if market rental rates are expected to increase. A tenant is likely going to want a shorter lease, the owner should carefully consider the desired lease term prior to negotiations.
Potential Subletting Issues
The lease should clearly obligate the tenant to pay the total amount of rent in the lease. If a tenants business is not successful, the lease will only be as strong as the tenant and the guarantor’s financial condition. The owner should seek a credit guarantee from a responsible party and/or a letter of credit from a bank. (It may also be a good idea for the owner and tenant to decide whether a partner who signed the lease and then exists the company is to remain liable on the lease.)
Emergency, Disaster, Damage, or Destruction of Property
Mitigate risk by making sure tenant has adequate insurance from a highly rated carrier covering all potential catastrophes. Both the owner and the tenant should have insurance with mutual subrogation waivers.
Tenant May Not Abide by Property Use Requirements
Tenant may change their business or use the space in a way not intended by owner and in such a way that does not benefit the building. Owner should incorporate a specific-use provision into the lease to ensure that the tenant cannot change their business.
Tenant May Desire to Transfer Their Lease
Owner should control approval of a transfer right to ensure that any new tenant conforms to the specified-use provision and will meet all financial requirements.
Tenant May Attempt to Surrender the Property
A continuous operating clause would require the tenant to remain open. If a business stops operating without terminating the lease, the owner may want the option to recapture the property after a certain amount of time to get a new tenant and reduce the consequences from a tenant going dark.
A Rent Term May Become Inadequate
A good rent at the time of the signing of the lease may become inadequate as the result of inflation. The owner should provide an annual rent reassessment based on the Consumer Price Index.
Unauthorized Tenant Improvements
Tenant may conduct unwanted construction or put up undesirable signage. Owner will want to retain property operational approval rights to avoid situations where a tenant does something that is detrimental to the property or to other tenants.
Delays in Construction
Both parties can incur substantial unforeseen or hidden construction costs from delays in construction related to modifying the space to the tenants needs. The owner will want to agree on a detailed tenant work letter and restrict permissible improvements as well as retain the ability to select contractors.
Owner will be responsible for major structural aspects of the building and building systems. Thus, it is important to try and plan in advance for anything that may arise.
Compliance with Commercial Use Laws
The owner must ensure that the commercial use is permitted on the property and that the property will satisfy the specific type of commercial use for the tenant’s activities.
Compliance with Lease Provisions
For example, if there is an exclusive use provision in a tenants lease the owner must make sure to comply with it in terms of other tenants.
Ensure that there is enough parking for all tenants.
Tenant’s Failure to Comply with Laws
Tenant may not comply with all laws, ordinance, orders, rules or regulations relating to the use of the property. The tenant may also not comply with standards of health, sanitation, and safety required by law.
Tenant may stay beyond the term of the lease.
Statute of Frauds Compliance
If a lease will be longer than one year, there must be a writing of some sort expressing the consideration. The owner’s failure to have a writing will result in a void contract. Minnesota Statutes section 513.05
Potential Property Issues
Need to Find New Tenant
A vacancy may result from a tenants lease ending or the tenant breaching its lease, going dark, and leaving, but either way an empty space is not good for the buildings image. It may take a while to find a new tenant. The owner should have a plan in place for finding new tenants.
Ensure Compliance with Section 1128(B)(b) of the Social Security Act
If the rental agreement is between a physician and suppliers to whom the physician generates business the owner will want to comply with the space rental safe harbor to the anit-kickback statute.
Owners may “protect themselves against liability resulting from their own negligence” through an exculpatory clause; however, a clause that “is either ambiguous in scope or purports to release the benefited party from liability for intentional, willful or wanton acts, it will not be enforced.” Schlobohm v. Spa Petie, Inc, 362 N.W.2d 920, 922-23 (Minn. 982).
Documents You Should Have
Some forms that an owner, acting as a landlord will want to have:
Commercial Lease Application
This form will be given to potential tenants to sign. It will contain required disclosures and authorize the release of information.
Letter of Intent
A preliminary agreement stating the proposed terms for the final contract. The terms may be binding or non-binding.
Commercial Lease Agreement
An agreement between a landlord and a business outlining the terms and conditions of the rental of the property being used for business or commercial purposes.
Assignment of Lease
Used to create a commercial assignment by a tenant or landlord.
Landlord Closing Statement
This form would be used to record any deposits and credits, money that has been given to the owner or the money that the tenant owes the landlord.
Landlord to Tenant Lease Termination Notice
A letter that the owner will give to the tenant to give them notice of the end of a lease and informing the tenant of either their option to end the lease agreement or sign a renewal lease.
Letter of Default
A notice form that may be given to tenant listing the specific breaches and deadline to cure the breach.
Lease Renewal Agreement
Written agreement to renew a lease that is about to expire.
Agreement that assigns a lease from a current tenant to a new tenant and continues the lease.