Most of my students have come across to commercial from residential investing, and it takes some education to make that switch.
This is especially important when it comes to leases.
Commercial leases differ from residential lease agreements in that they are less standardised and there is usually much more room for negotiation.
It's where you can get really creative, so you definitely don't want to leave it to a managing agent to give your new tenant a boilerplate lease.
As a commercial property landlord, you need to be aware of the types of clauses that can be included in a lease agreement to address possible issues arising with tenants.
It's a basic part of covering your a**, but it's also a way of making sure your tenant is also covered and that everyone fully understands what will happen in any given situation.
Below, we offer our guidelines on some of the most significant clauses to be considered.
1. Tenant subletting and lease assignment
To prevent a tenant subletting a commercial unit or assigning the lease to another party without your authorisation, an assignment and subletting clause should be included in the lease agreement to outline the tenant’s restrictions on occupancy.
2. Handling maintenance issues
The tenant’s responsibilities on repairs and maintenance should be clearly specified in the lease agreement, including the terms for keeping the space clean and the tenant’s duty to pay for any damages caused by neglect or abuse.
I always negotiate for the tenant to handle all repairs and insurance for the property, consult with a solicitor on drafting a Full Repairs and Insurance (FRI) lease, which removes the landlord’s liability for the cost of all insurance and repairs.
Add to this clauses about how you would like the property to be left if they leave at the end of the contract…
They may have done improvements which mean that you want to take advantage of those by not stating the property needs to be returned to it's original state… You want it better… but not worse…
3. Ending the lease early
If either you or the tenant wishes to end the lease early, break clauses should be included in the agreement to enable this.
Break clauses should specify exactly how notice must be given by either party, outlining the required steps to be followed when serving notice.
If these contractual requirements aren’t met, the notice will be void.
Also, if they break the contract because they go out of business or can't pay the rent, you can ask that they have a rental guarantee in place from the bank. It's rarely happens – but this clause did save my bacon once.
4. Service charge disputes
To pre-empt service charge disputes, your lease must be clear and specific about the expenditure covered by the service charge, as the leaseholder will only be obligated to pay for exactly what is specified in the agreement.
5. Rent review disputes
Commercial lease agreements usually rental reviews every 3 or 5 years (depending on the term of the lease). It's standard to include annual rental increased in line with CPI or a specific percentage. Rental review are just used to check whether that's still fair and right…
Say rent increases by 5% in one year but CPI by 6% – then you can increase rent to be in line with CPI – and vice versa if it's the other way.
Rent review clauses should include provisions on how to handle any rent review disputes with the tenant, such as mediation, arbitration, or calling on the services of an independent expert valuator. If you are being fair and in line with the market rent in the area in my experience arguments about this never happen. (I've never had one)
Insurance provisions are essential in a commercial agreement, as there is no regulation mandating who should pay for which policies, even where a policy may cover both parties. As such, insurance provisions should include the following:
State that the tenant’s personal property will not be insured by the landlord for loss or damages
Specify which insurance policies are to be maintained by the landlord and by the tenant, including policies for property damage, loss of rent, public liability, and any other necessary coverage for the premises. This is essential for preventing disputes.
It's important to note that even though I require all tenants to hold public liability insurance in case someone trips and breaks something important, I always maintain my own as well…
If the tenant let's their laps for any reason I want to know that I' still covered… to me, it's just the cost of doing business, and you'll take it out of their rent right from the get go.
Drafting commercial leases is a detailed and creative business… So make sure you have a lawyer experienced in commercial leases… That being said… it's up to you to get educated and make sure that they include the clauses that will keep you covered.