Key Terms To Optimize Your Industrial Lease
Negotiating Clauses Such as Free Rent, Use and the Commencement Date in Your Industrial Lease Proposal
When negotiating an industrial lease proposal, it is more important than ever to strike the appropriate balance between achieving terms that suit your company’s needs and being practical with regard to current market dynamics. With the explosive growth of e-commerce over the past decade, and its further acceleration during the pandemic, industrial properties have never been in greater demand. Tenants can no longer anticipate concessions such as four or five months of free rent and generous tenant improvement allowances. This is a landlord’s market, and it will likely remain that way for the foreseeable future.
But it is possible for tenants to even the proverbial playing field. Developing an understanding of the key terms and provisions that should be included in your industrial lease proposal will help secure your company’s ideal property or space and maintain the success of your business.
Critical Industrial Lease Terms
In developing your lease proposal, it is advisable to try to keep it as simple as possible, while covering all of the elements that are salient to your company. The most critical lease terms that virtually any industrial tenant should cover in a proposal are:
- Corporate entity.
- Commencement date.
- Early occupancy.
- Free rent.
- Base Rate — amount, type and annual escalations.
- Tenant improvement allowance.
- Security deposit.
- Broker commission.
The premises refers to the space in question. While it might seem obvious that you need to clearly identify the space that you wish to lease, people often miss multiple small details, which can create ambiguity. Start with the full property address, city, state and zip code and include the suite number or letter if there is one.
Next, add the space’s estimated square footage. Bear in mind, however, that all commercial space measurements are approximations. Nonetheless, the estimate featured in your lease will be utilized to calculate your monthly and annual rent payments. While tenants often will endeavor to negotiate (and minimize) the estimated size of the premises, this tactic is unsuccessful 95% of the time, and I usually advise clients against it. If you need a source for verifying the space’s measurements, you or your broker can refer to the Building Owners and Managers Association’s (BOMA) published guide to industrial property measurements.
It is important to clearly identify the corporate entity that will be attached to the lease documentation. Firstly, that entity must match the financials that you provide to the landlord for review and to securitize the lease. Secondly, with medium-sized and larger businesses, there are often multiple legal entities underneath the corporate umbrella, and the landlord will want transparency about which entity is renting the space and what its relationship is to the corporate office.
The use clause in industrial leases is more important than ever, particularly because environmental and zoning regulations are increasingly strict in urban and suburban marketplaces that are close to large population centers. In the past, a standard industrial use clause might have identified an auto parts factory as being used for “the manufacturing and distribution of automotive products.” In today’s environment, though, landlords are seeking greater specificity. They want to know details about what production processes are undertaken in the space; how many people will be on the property; how many parking spaces are required; hours of operation; equipment and materials utilized; how those materials are handled and disposed of; as well as expected noise levels and smells produced via exhaust.
The commencement date is the date you want the lease to start. In the absence of free rent, this also represents the first day you begin paying rent for the space. It is recommended you work with the landlord to identify a commencement date that is amenable to both of you. If you are relocating, you’ll want to avoid a commencement date that significantly overlaps with your existing lease, in order to bypass double rent. On the other hand, you don’t want to cut things too close either; if your existing lease ends one day and your new lease starts the next, it creates undue pressure to affect a swift and seamless relocation.
Early occupancy refers to the period of time during which you have the right to install your FF&E (furniture, fixtures and equipment), but are not responsible for paying rent for the space. Many novices forget to add this to their proposals and miss out on an opportunity to ensure an efficient transition. When you push the commencement date back a month or two and negotiate early occupancy, you create a window when you can have your electrician, contractors, material handling, IT and furniture vendors inspect the space to make sure it is arranged appropriately for your business, as well as begin phasing your move-in to enable minimal disruption and downtime.
Free rent is exactly what it sounds like: a period of time during which you are occupying the space, but not paying rent. How much free rent you can secure depends on local market dynamics, as well as your company’s credit, use and requirements. On average, most industrial tenants can expect to receive one to two months of free rent.
Base Rate — Amount, Type and Annual Escalations
You will always include the amount of rent you are proposing to pay for the space, along with the type of lease that you are seeking, i.e., gross, modified gross or triple net. In addition, you will want to detail the annual escalations (increases in rent and/or common area maintenance charges) that you are suggesting.
Tenant Improvement Allowance
In order to identify the appropriate tenant improvement allowance to request from a landlord, you should begin by developing a list of requirements you have for your space, as well as additional improvements that you would like but are not strictly necessary. Next, communicate these needs to your architect. A good architect can help you then identify a lump sum or dollar per square foot amount that you should request from the landlord. If you don’t have an architect, you can provide the same list of priorities to the landlord, who will then work with their architect and contractor to develop a budget estimate. If you can and would like to provide your own tenant improvements, ask for free rent in lieu of a tenant improvement allowance. In such a scenario, not only are you saving the landlord the money required to pay for the improvements, but also the time and energy necessary to facilitate the process with the architect and contractor. This easing of the landlord’s burden should be factored into your free rent request.
Rationalize how much your security deposit should be and propose what you think is fair. Based on their credit, large corporations can sometimes forego providing a security deposit at all. Generally, though, one month of security is standard for approximately 80% of industrial leases in most size ranges. The main factors that will dictate the size of the security deposit are your credit, the amount of tenant improvement allowance you would like the landlord to contribute and the length of the lease term you are proposing.
Broker commissions are anticipated costs for landlords. However, this arrangement, as well as the amount of the commission, should be clearly articulated within the proposal to avoid any potential miscommunication.
Additional Industrial Lease Terms To Consider
As the situation allows, or if there are specific areas of concern, you should include, or add additional detail to, some or all of the following clauses to enhance your industrial lease proposal:
- Company background.
- Trailer parking.
- Fenced yard.
- Lease audit rights.
- Environmental indemnity.
The more information you can provide to the landlord — such as how long you have been in business, your growth projections, the types of products you manufacture and distribute, your current property and rental rate — the more they will understand your company’s story and be able to envision the advantages offered by your tenancy. This, in turn, will make them more amenable to granting your company’s requests, from your desired tenant improvement allowance to the number of parking spaces you require.
Speaking of which, it’s important to consider how many parking spaces your business will need for employees and visitors, both now and in the future. Consider if any of the spaces are reserved, or if it makes sense to demarcate which spaces are for your company.
If you are in the third-party logistics business or any other industry that has a major logistics component, you want to make sure that you have enough trailer stalls; that you can maneuver into your loading docks when your trailer stalls are in use; and that your containers are safe and secure during and after operating hours.
You will want to ensure your company’s tractor, trailer and container safety and should review whether it is imperative for you to have a fully fenced yard, or if sharing a truck court is practical. Oftentimes, you can negotiate fencing of the yard, if that is both desired and feasible.
Think of leasing industrial space as akin to applying for a mortgage; be organized in advance. Who do you think gets better lease terms: the company that presents their financials promptly and in an orderly package, or the company that has to wait two weeks for their CPA to come back from vacation, whose tax return is on extension, whose bookkeeping is not complete and who only has an up-to-date P&L and balance sheet from the prior year?
It may seem like a given that the building will have all of the basic structural amenities and features, and that these will be in good working order and condition. Unfortunately, that isn’t always the case, and it is often worth clearly noting the areas of the building that have deferred maintenance. This approach will ensure that your tenant improvement allowance isn’t used to fix items that are the landlord’s responsibility and will guarantee that the landlord doesn’t neglect to make any necessary repairs before you take occupancy.
Lease Audit Rights
You can expect to receive a common area reconciliation bill every spring that bills you for the balance between the estimated operating expenses and the actuals costs. It could be worthwhile to negotiate for audit rights, so that you can make sure that the expenses are fair and accurate.
If you get even a whiff of environmental concerns (pun intended), make sure that you dig deeper into the issue. Specifically, make certain that you take the following steps to ameliorate any potential problems related to environmental issues at the property:
- Ensure that your team will be safe upon occupancy of the property.
- Establish that you are aware of any and all ongoing cleanup that might affect your occupancy and use of the property.
- Review all documentation and, more importantly, test results for the property.
- Negotiate an indemnity so that you are never held responsible for the landlord’s environmental liability.
It's important to consider the building systems within the property and ask for a warranty of the HVAC systems, as well as all other building operating systems, for a period of approximately 30 days to six months. Novice tenants often settle for no warranty period at all. Savvy tenants can sometimes secure one-year warranties and, in less competitive markets, can even have the systems warrantied for the entire lease.
Last, but definitely not least, is the surrender clause. This is the clause that details the condition in which you will return property to the landlord at the end of the lease. If you are installing extra HVAC units, racking, electrical conduit, silo supply lines, heavy machinery, footers, second-story office space or a steel mezzanine, you want to be 100% clear on what your responsibility is to remove said systems at the end of the lease. If you are clarion on this upfront, you can save hundreds of thousands of dollars at the end of the lease.