Perhaps the toughest issue on a lease renewal is the determination of the fair market rent for the renewal term. A well-drafted lease will create an arbitration procedure that is equitable and will provide an incentive for both parties to come to terms rather than arbitrate.
In this issue we look at an approach that we recently encountered in a lease with a large national institutional landlord that was overreaching and which we hope is not the start of an inequitable trend.
It turns out that being a commercial leasing lawyer can be life threatening.
I am not just talking about reading eye-straining 200 page leases or mind bending run-on sentences. It is the sitting while we read that scintillating prose.
The media is buzzing with the negative long term effects of sitting, which can lead to increased risk for cancer, diabetes and cardiovascular disease and a tendency to say “heretofore” and refer to “the party of the first part”.
Just putting together this newsletter, I selflessly put my life at risk to bring commercial leasing into your life.
Even regular exercise may not compensate since sitting itself can cause physiological effects, so you are not off the hook because you went on that morning run or swim.
And think of the ammunition for those smug standing or treadmill desk touting, rolling ball chair using, ergonomically born again co-workers happily moving and bouncing their way through the work day.
Depressing enough to make you want to sit down.
The commercial leasing version of sitting can be positive; relaxing, putting your feet up and staying put as you renew your lease.
In a recent issue, we covered renewal rights, which should be negotiated up front during the term sheet stage, determine a “fair market rental” based on an objective methodology and resolve disputes through arbitration.
In fact, we concluded that a properly drafted arbitration provision is so equitable that it is hardly ever invoked because the parties have every incentive to avoid arbitration and negotiate a mutually beneficial outcome.
Recently, however, we came upon a troublesome approach by a large national institutional landlord and did not feel that we could accept their proposal sitting down.
As with many landlords, this landlord wanted to limit the arbitrator’s universe of relevant factors to determine fair market rent to those that favor the landlord and we insisted that the arbitrator be allowed to look at “all relevant factors”.
But this landlord went one step further.
Most lease renewal provisions assume that the landlord will not be providing typical concessions going forward (e.g., free rent, a tenant improvement allowance, etc.) and that such lack of concessions will be thrown into the mix to determine the fair market rent.
This landlord was offering first refusal space and renewal rights and treated the two different options in a similar manner by requiring that it be entitled to provide specified concessions to the tenant in each instance and that the value of these factors then be deducted from the fair market rental.
The thinking was that by providing more concessions the base rent would be higher and this would be viewed more favorably in the market by the landlord’s lenders and investors.
This is because landlords do not really provide tenant concessions so much as finance tenant concessions. If a landlord offers its tenant a tenant improvement allowance it receives this money back over the term of the lease in a higher rent with an interest factor.
Some concessions along these lines may be fine (e.g., marketplace free rent), but other concessions only make sense when taking right of first refusal or option space, not when renewing an existing lease (e.g., a tenant improvement allowance).
Make sure that the chair is not pulled out from under you if your landlord attempts to require particular tenant concessions on a renewal by addressing the following four issues:
Push for no concessions and “all relevant factors”. The best solution in this situation is to insist that you not be obligated to accept, and your landlord not be entitled to provide, any tenant concessions on a renewal and that the arbitrator be empowered to look at “all relevant factors” so as to determine the appropriate fair market rent. That is how we prevailed in the lease with the institutional landlord in the example above (it would be easier to avoid this issue in a larger lease, but harder as a smaller tenant with less leverage).
If your landlord insists on “including without limitation” some specific items that must be considered by the arbitrator that is okay, as long as such items are fairly stated and do not preclude the arbitrator from reviewing all other relevant factors.
Be clear on the actual concessions. If you cannot avoid this “concessions included” approach, make sure that your lease is very clear that your landlord is actually providing the particular concessions. Generally, if an arbitrator determines that similar leases in similar buildings in the area are receiving six months “free rent” concessions, it will be assumed that since your landlord is not providing such six months rental concession on a renewal your fair market rent will be lower than what is seen in the marketplace for a new lease. But if the assumption stated in your lease is that you are in fact receiving that 6 month concession, such “free rent” will be amortized over the term of your lease and your fair market rent will be higher, commensurate with what is seen in the marketplace for a new lease. Surprisingly, the institutional landlord’s lease included the assumption to be applied by the arbitrator, but without being clear that the tenant was actually entitled to the six months rental concession on which such assumption was based.
Avoid unneeded concessions. Do not let your landlord require that you accept unnecessary concessions. For example, our institutional landlord friend was requiring that the tenant accept a build out allowance with only 50% of the aggregate sum applicable toward rent if unused. That might be acceptable with respect to an initial buildout, but most tenants on a renewal do not need or want a large tenant improvement allowance since they are likely to only re-paint and carpet.
First refusal or option space can be different. Requiring particular concessions would not necessarily be such an issue and is more common if you are first taking additional space. Renewals are a special animal and applying standards that work in other situations must be avoided when it puts your tenancy at a disadvantage.
Disclosure: I tapped out this newsletter on my laptop perched on one leg while doing deep knee bends on top of a medicine ball. With that kind of balance, you will be well protected in determining fair market rent under your lease renewal provision.
Full Disclosure: not everything in the previous sentence is completely accurate, although I think I may have a medicine ball somewhere.