First commercial lease negotiation

13 Replies

I bought a 2 unit commercial building and have had it listed for about 6 months. The vacant half is configured as a large high-end hair salon, the other half is occupied by me.

I'm really excited to have my first interested party. But I'm feeling a bit nervous about the terms they're asking for, and I wanted to see what kind of input you all might have.

- I initially offered 3 months free rent to help get a business off the ground.
- They came back at me with 6 months free, no rent increase until 2022, AND I need to replace the windows, submeter water, replace some decking, do landscaping.
- I am just about to come back at them with no free rent, but I'll pay for their build out up to the value of 5 months of rent, plus windows/meters/ramp.

Now I'm realizing that that whole package is a ton of money, and I won't make any money for over a year. My agent is treating it as normal, is it normal?

I can understand that yeah the windows are needed because it's a fancy salon with an image to uphold, but at the same time if I just waited 1 year, I might find a tenant who would handle their own build out, and I might break even.

I'm also nervous about:

1. This isn't even an established company, there's some risk on the tenants themselves.
2. It's a bit wishy-washy who's responsible for their HVAC equipment, they want maintenance to be included in CAM which means I pay half of it. I want them to be responsible for filters/cleaning. I want to be between 20% and 90% responsible for replacement units if needed, but I'm not sure how to say that and what value is appropriate. On the other hand I'm ok with us firming up that all HVAC work is part of CAM, so I pay 50% of it always.
3. They're requesting I take on some initial landscaping outside of CA

Some additional background: It's a stand-alone building in the suburbs of Boston about a quarter mile from the highway and a large shopping center. I've had one tour every 45 days since listing. A sewing school and comic book shop decided it wasn't for them, most of the interest has come from hairdressers who are trying to start their own salon but mine is sized for a larger operation. I've been trying to catch a dentist or someone who wants to convert to office space, but I'm fine with a salon. I don't realistically know if I'm better off with the first offer or waiting it out.

What do you all think? Normal or too good of a deal?

Welcome to commercial real estate... It all depends on the strength of your market and the strength of the tenant. It sounds like your market is rather weak so you will probably end up eating some TI's (tenant improvements). In the Seattle area retail spaces almost always are built out by the tenant with a few months free rent thrown in by the landlord for construction. Office build outs are usually done by the landlord. The landlords almost always do all the exterior work like landscaping and exterior maintenance as part of the NNN. Since you have been in your side for a while you have a historical record of your water use so it should be easy to tell how much the other tenant uses so you shouldn't have to separate the water. It is always nice to have separate meters, but not mandatory. HVAC maintenance is a real toss up. Usually the tenant does the maintenance and the landlord does the major repairs, but it can go either way. If it is a shared unit it would be safer if you just did all of the maintenance in the NNN. How long is the lease the new tenant wants? If 5 years then usually 2-3 months free (they usually have to pay for NNN even during the free months) or a graduated increase from low starting rent. If it is a start up business be sure to get a personal guarantee on the lease and personal financial statements so you know if they have anything to go after if they default. If it was someone like Starbucks they will ask for the moon and get it because you will always get paid.

Get yourself a good real estate lawyer who can write up a good lease for you and answer all of your legal questions (which you should have a lot of to start out). Sometimes you can find a commercial lease you can uses, but the rules are different if every state so it would have to be something written up that is local to you. It is tough to not know what you don't know. There are so many ins and outs of the commercial market and every area is different.

Good luck.

@Kavi Siegel experiences with small commercial spaces but hardly an expert.

With a hair salon you definitely want to separate the water and get it on the tenants books. They use a LOT of water.

How long is the lease and more importantly what is the break even period on the improvements.?

Is it one hvac per unit that’s ideal then maintenance on them replacement on you. I’d stipulate you get a maintenance contract for annual inspections etc.

I wouldn't do any of their build out because there is such incentive to complain about your work and price. Make them do the egwork and come to you with proposals for your approval and offer an offsetting amount you are comfortable with for their specific equipment.

Restoration rights and or ownership of equipment at end of lease? Security deposit?

I think of hair salons as m bottom tier of tenants unless it's markedly high end.so I'm not sure you gain much by going overboard. Landscaping can also be a nightmare for a retail-based business landlord, so outline it very clearly what you want to do and are willing to do. Perhaps get something set then pass the cost of maintenance and water to them. Fresh plants and flowers and attractive displayers can be shockingly expensive and if they want that level of attractiveness they need to pay for that

I’m sure others have better insight but hopefully that’s somewhat helpful

Sounds like you are putting extensive though into it, which is great.  Ultimately you have to decide if you think they will be a long term tenants.  If so, then I'm sure the up front capital is worth it.  I wouldn't spend too much money on upgrades that will only be beneficial to the prospect tenant. In case they only stay for one year, you want the upgrades to apply to a wide base of tenants. 

You've gotten great feedback so far. My best advice is to be very concise when talking to your RE lawyer, if he's not on a flat fee, you can easily rack up 10-15 hours for this level of negotiation. Did you formulate tenant guidelines with your broker prior to listing? You should think about how much negotiation you're willing to do and follow your own rules. 

Good luck!

The deal fell apart at the start of COVID when the Mass gov shut down non-essentials, but it came alive just last week where we agreed to continue with the lease we had drawn up 2 months ago.

They tried to pull a fast one and request an additional $16k worth of value "because of covid," but snapped back to the original contract when I said I'm not interested at all. 

In the end, I agreed to $10k in improvements, 2 months free rent, replace half the windows, install submeters, re-line the parking lot, and some initial landscaping on my dime rather than on CAM.

Total package ended up being worth about 10 months of rent out of a 5-year lease, (Napkin math: $20k) and the improvements do have some value to me, as well as being tax-deductible at 100% as QIP. After 8 months of vacancy and slow interest, I decided it was worthwhile to agree to it. They're also paying their share of taxes and other expenses as additional rent / CAM, so if I was to think about this as residential lease math, it's more like 6 months free rent. I'm pretty neutral about it, borderline happy.  

So far the tenants are just getting their build-out going and they seem like they're going to do well. 

@Kavi Siegel Congrats on your first commercial lease negotiation!  I am happy for you.  I was going through the same thing, had a vacant prior to covid and was in negotiating with a potential mom-n-pop Mexican restaurant tenant.  Got the guy to agree verbally to 5 years lease, 3 months free rent, 12k TI, no rent increase first 2 years but rent bump is 3% annually after that.  So right when I was about to look for a lawyer to draw up the lease that's when covid hit and of course the guy said he needed to put it on hold to see how things play out.  Texas just opened back up started last week so I am giving it a few more days and will reach out to him again.  Hope I will be lucky like you and he is still interested in the deal.

Just got a call from a guy asking if we lease to CBD store.  Seems he doesn't care too much about the rent rate (since that business is making good money I assume).  Not sure what to think about that.  

Their first payment was first month's rent (third month of occupancy, so they begin regular rent payments on the fourth month) last month's rent, a $3,000 deposit (arbitrary number ~1.5 months), first month's CAM, first month's taxes. The total of the payment is 85% of the TI I'm paying right back out to their contractors, so once again I didn't feel too bad about it. 

I also paid a $2,000 commission to their agent, my agent didn't take commission due to some history, and I'm turning a blind eye to how seemingly odd that part of the transaction was. 

@Kavi Siegel nice job.  You got them agreed to pay last month rent un front too.  Will remember that next time.  Just 1 more question: for the 2 months free rent, was it totally free or you made them pay tax, insurance for those 2 months?

They are paying tax, insurance, CAM for the 2 free months.

I don't know how it is in your state, but in MA for residential leases you can't co-mingle funds and have to pay interest on deposits and up-fronts. My attorney specifically put wording in to say I'll be co-mingling funds and not paying interest, which I guess is standard, but it did warm my heart just a little bit. Allows me to use that to fund their TI and just eat a little of the cost at the end. 

My next thing to figure out is how I want to configure billing in my online payments software (Cozy.co) - if I want to wrap all 3 into one payment, or have rent and additional rent as separate items. 

@Kavi Siegel thanks for taking the time and answering all of my questions. Really appreciate it.  Once again I am truly happy for you on your first commercial lease deal.  Good luck, stay safe, and happy investing.