By Carrie Kreydick and John-Paul Wolfe
In commercial real estate, the letter of intent (LOI) is a very important aspect of commercial real estate lease negotiations. To help out any rookies out there, we decided to dissect the LOI and give new agents a better understanding of the business terms that should be addressed by this important document. The LOI should be as specific as possible to avoid pitfalls in the lease negotiations.
When a residential agent makes an offer on a property for a client, he/she fills out a contract with the deal points, has the buyer write an earnest deposit check and submits the offer to the seller’s agent for review. The process is similar in commercial leasing, but negotiations are done through letters of intent. Be prepared to spend a significant amount of time going back and forth with the cooperating agent or owner on the LOI. This is where the business points that will be incorporated into the lease get hammered out. Get familiar with the standard terminology because you shouldn’t negotiate a deal without knowing what it means.
The LOI is typically submitted to the landlord or the landlord’s agent, from the tenant or the tenant’s agent, and should address the following business terms and issues. The list of terms is comprehensive, but only the terms that are relevant to a specific deal should be used.
Tenant: Name the person and business entity that will be the responsible party. Don’t forget that the tenant could have a parent company, partners or other entities with a vested interest in the business, and they should be named if they are guaranteeing any part of the lease.
Use: Describe the tenant’s business in simple terms.
Landlord: The entity that is receiving the rent checks should be identified. If it’s unknown, then a simple TBD (to be determined) will do, but clarification is necessary later in the process.
Term: The initial length of the lease desired by the tenant, in years.
Base Rental Rate: The base rental rate should be expressed on a per-square-foot, annual basis.
Lease Type: We’ve discussed lease types before (triple net, modified gross and gross). The lease type is important as it defines who is responsible for maintenance, insurance and real estate taxes.
Annual Escalations: These are typically between 2 and 4 percent, but sometimes tied to the Consumer Price Index. The reason for the annual escalation is to compensate the landlord for inflation during the lease term.
Option Periods: The tenant may want to have the option to extend the lease past the expiration date. Option periods are usually the same, or shorter than, the initial lease term.
Lease Commencement Date: The broker should identify the date the lease will begin. This may, or may not, coincide with possession and rent commencement.
Possession Date: The date the space will be turned over to the tenant should be clarified.
Rent Commencement Date: Rent commencement is not the same as lease commencement. If there is build out required, a free rent period may be given to the tenant. The rent commencement date, therefore, identifies the date the tenant will start paying rent.
Exclusivity: When tenants take space adjacent to other tenants, they usually want a clause in their lease giving them the exclusive right to sell whatever it is that they are selling. This is typical in strip centers, malls and multiple-tenant mixed-use properties.
Percentage Rent: Sometimes, in lieu of additional rent, a landlord will take a percentage of a tenant’s profits.
Security Deposit: Depending on the type and credit quality of a tenant, the landlord will usually require a security deposit.
Guarantee: Most Landlords will require a lease to be guaranteed by the corporation, or the person leasing the space. It gives the landlord recourse should the tenant default.
Real Estate Taxes: In retail, most tenants are paying the real estate taxes associated with their spaces. In office, the base year taxes are included in the base rent and any increase is passed through to the tenant. Regardless, it should always be determined who is responsible for tax payments.
Common Area Maintenance: There is usually a common area maintenance charge, similar to an assessment. It should cover garbage and snow removal, parking lots, building maintenance, etc.
Parking: If the tenant has the right to some parking, it should be identified in the LOI.
Utilities: Determine who is responsible for paying all utilities, including water.
Tenant Improvement Allowance: In new developments and larger spaces, landlords may offer build-out funds as an incentive. Identify these funds in the LOI.
Landlord’s Work (Delivery Condition): The tenant should be specific as to the way the space is to be delivered by the landlord.
Signage: The tenant needs to get signage approval from the landlord and should discuss it prior to lease.
Right of First Refusal: The tenant may want the option to lease additional adjacent space, or purchase its space. At the very least the tenant should ask to be notified if an offer is made on the space, and ask for the chance to match it.
Licensing Approval, Franchise Approval: Some tenants need additional approval on sites prior to moving forward with a lease. This should be addressed in the LOI, giving the landlord a chance to fully understand the deal on the table.
Sublease/Assignment: The tenant should have the right to sublease a space to another tenant of equal or greater credit, or assign the lease to a parent company. If the business is going south, the tenant needs to get out of its obligation and the landlord needs to help mitigate the tenant’s damages.
Brokerage: We always recommend identifying the brokers involved in the deal. Note who is representing the tenant and who is representing the landlord. Do not use this clause to negotiate your commission. You want to have your commission negotiated prior to submitting a letter of Intent.
Remember that letters of intent are non-binding, and even if the business points are decided upon prior to having a lease drafted, there are still hurdles to jump before the deal is done. However, having a detailed and definitive LOI lowers the odds of any surprises during lease negotiations.
CARRIE KREYDICK IS THE DIRECTOR OF BUSINESS DEVELOPMENT AT NEW WEST COMMERCIAL AND JOHN-PAUL WOLFE IS THE DIRECTOR OF COMMERCIAL BROKERAGE AT NEW WEST COMMERCIAL. KREYDICK CAN BE REACHED AT [email protected] AND WOLFE CAN BE REACHED AT [email protected]
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