As explained in a previous article, tenants should always have a lease in writing, and depending on the state in which the premises lies, other requirements may affect the validity of your lease. Aside from state-specific requirements and essential terms (parties, monetary obligations, premises and length of the term) needed to validate your lease, restaurant tenants must also be wary of landlord-friendly leases.
One big mistake tenants make is signing a lease without understanding the obligations and consequences provided within the lease. Paying close attention to specific obligations and negotiating tenant-friendly terms is imperative prior to executing a lease.
Common Negotiable Terms
Renewal Rent Increases – Typically, it is best for the tenant to have a fixed amount for rental increases. A renewal provision providing rent increases to be “fair market value” is risky and uncertain. With a fixed amount established, negotiating down the fixed amount when it’s time for renewal is much easier than being forced to accept fair market value. If for some reason market conditions indicate that the fixed amount is too high, a tenant can typically negotiate the increase down to market value by simply indicating the potential to relocate.
One big mistake tenants make is signing a lease without understanding the obligations and consequences provided within the lease.
Tenant Improvements – How much a tenant can get for a Tenant Improvement (TI) allowance is driven by the value the tenant brings to the shopping center. Tenants that receive a TI allowance should request a draw schedule, which allows a tenant to receive money during the process of the build out of the TI, not after occupancy. It’s worth requesting one installment at lease execution for anticipated costs of plans, one midway through the build out and one upon opening. Percentage of completion draw schedules, such as 25% or 1/3 draws are most common (i.e. when 25% of work is completed, 25% of TI allowance is remitted and so on).
Common Area Maintenance (CAM) Costs Increases – Without negotiating a cap on CAM, one will not be offered to a tenant. It’s typical to request a cap (5%), for increases to controllable CAM costs. Be prepared for landlords to throw back cap-excluded expenses – typically phrased as “uncontrollable expenses” (i.e. snow removal, insurance, real estate taxes and assessments, security, utilities). Pay close attention to these exclusions in order to prepare accordingly for unpredictable increases to cap-excluded expenses.
Security Deposit – It is typical to see an amount equivalent to first month’s rent for a security deposit (base rent + tenant’s share of operating expenses). Though, if you are investing any sizeable amount, no security deposit should be required. Alternatively, if a deposit is requested, you can negotiate for a “burn off” where the deposit be applied to rent after an agreed amount of time. Two to three years is most common.
Abated Rent – Some leases allow tenants free rent for the first few months of operations, but have fall-back language indicating tenant’s obligation to pay back abated rent in the event of default. Tenants should first negotiate no abated rent would be due by tenant, and at the very least, only be obligated to pay the unamortized portion of abated rent.
Landlord Default – Almost no landlord-drafted leases include a provision describing what happens if the landlord defaults. Request a “set-off” of an agreed upon amount of base rent upon a landlord default. Alternatively, including a “performance under protest” provision would allow the tenant to undertake work while continuing to pay rent, and at the same time, preserving rights to proceed against the landlord at a later date.
Tenant Default – Negotiate a cap on damages or limit damages to actual damages, not consequential. Leases providing a landlord the ability to seek consequential damages can expose you to massive liability.
Continuous Operation – Many restaurant tenants have found out the hard way that they can lose a lot more money by continuing to operate, rather than closing and paying rent. Attempt to negotiate (1) an early termination option (typically requiring the payment of unamortized TI and lease commissions) or (2) attempt to get a right to “go dark” even if for a limited period of time. This could also have an effect on the landlord’s ability to obtain “consequential damages” as a result of tenant’s default.
Relocation – It’s worth requesting terms that (1) limit the landlord’s rights in relocating your restaurant; (2) require at least 90 days’ notice of relocation; (3) require the landlord to pay cost of relocation and / or consequential damages for relocation; (4) require comparable space – consider size, location, restricted use, access, area; and (5) allow you to terminate the lease if the relocated premises is unacceptable.
Paying close attention to specific obligations and negotiating tenant-friendly terms is imperative prior to executing a lease.
Exclusive Use Rights – Including an exclusive use rights provision restricts the landlord from leasing other units in the shopping center to tenant-competing entities. Landlords do not want to limit their list of potential tenants, but tenants should consider including the following language: (1) defining the exclusive use; (2) scope of the landlord’s obligation to protect the exclusive use right; (3) who’s excluded; (4) tenant’s remedies in the event of the landlord breaching the provision; and (5) what events may trigger the termination of the exclusive use rights provision.
Assignment – You will want to preserve your right to sell your business or make internal changes. Be cautious of the landlord’s ability to terminate a lease due to a mere request for an assignment. Negotiate the right to withdraw the assignment request and preserve the lease. Also be cautious of language providing the landlord a cut of money related to the sale of the business in return for their consent to the assignment.
Liquor Permit – Landlords seem to have a growing interest in preserving liquor permits with locations. Expect that if the landlord is going to assist you in obtaining the liquor permit, they are going to want the right to retain it at the location. Though, it’s worth negotiating landlord’s payment to you for fair market value.
Alcoholic Beverages – Many landlords will include language permitting a tenant to serve alcohol at the premises, but only for consumption withinthe premises. Be sure to include language of permitted alcohol consumption in the patio area (if necessary) of the premises as well. Also, preserve your right to sell beer and wine for off-premises consumption.
Parking – Almost all leases allow landlords to modify the common areas or build additional structures. Make sure you have protected visibility and parking area, and that access to a particular public road cannot be modified without your consent.
Signage – Generally, leases will allow the tenant to install one sign in accordance with applicable legal and insurance requirements. Although it’s likely to be turned down, request installation and any permits required be at landlord’s expense.
Insurance – It’s important that TI is insured appropriately, especially if the building burns down. Most landlord leases provide insurance language that require the landlord to use proceeds to build back to the shell, while the tenant is required to restore TI. Obviously, you will want the insurance language to include requirements for landlord to build out to the point where the TI’s existed at the time of initial opening.
Holding Over – Most landlord leases provide at least 150 percent of base rent due to the landlord in the event of a tenant holding over. Negotiate down to 125 percent of the then existing base rent, which is fair and reasonable. Be careful with language providing for consequential damages.
Financial Information – You should first try to limit the information sought to gross sales. Then, make sure the landlord has covenanted to keep your financial information confidential, specifically including gross sales.
Percentage Rents Waiver – Always attempt to get a waiver of percentage rents for the first year with the understanding that while sales may be extremely high because of the “honeymoon” phase, profitability does not always follow.
Personal Guaranties – Always request no personal guaranty. At the very least, negotiate a “burn off” where the personal guaranty is only effective for one to three years, depending on the length of your lease.
Permitted Use – Most restaurant leases are general, indicating a permitted use as a full-service restaurant only. Negotiate language to include your permission to change the type of bar, food service, and / or entertainment concept of the permitted use. Another issue that has come up more often is noise. If your entertainment concept involves a great amount of noise (music, large crowds, live bands), be sure to include language that stipulates the landlord is aware and acknowledges that such concept / use by nature results in noise in excess of other types of permitted tenant uses (so long as the noise is consistent with commercially reasonable standards for restaurants / bars and applicable noise ordinances). Request your landlord experience the entertainment concept himself / herself in furtherance of that acknowledgment. This will limit the landlord in attempting to restrict your permitted use of music, live bands or other loud noise that a potential neighboring tenant may complain of.
Receiving a long, legal-heavy lease from a landlord can be daunting. It’s imperative that you are properly educated on, not only the common provisions indicated above, but all terms within your lease. Terms in a commercial lease are always negotiable, and restaurant tenants should seek proper legal advice from efficient and experienced real estate attorneys before putting pen to paper.