Leases, Subleases, and the Like

Your business expansion will enjoy more space very soon. Now your employees can park at their place of employment vs down the street. Crisp new offices or tons of manufacturing space await you in the new location. You cant’t wait!

You’ve opted to lease the new spot and postpone ownership. You’ll encounter two leasing scenarios once you scour the market for suitable addresses - leases and subleases. So what are the differences? Indulge me while I describe them.

Leases are negotiated directly with the owner of a parcel of commercial real estate. Therefore - they are referred to as direct leases. Normally - your initial conversations will be through your commercial real estate professional. The deal you get depends upon the landlord’s motivation, competition in the market and the skill with which your broker volleys. She will work with the owner’s rep to craft your agreement. Outlined will be a monthly payment amount - rent, number of years - term, increases in rent throughout the term - bumps, and concessions - free or abated rent, refurbishment, and extra stuff - tenant improvements. An early termination right, extension rights through an option to renew, right of first refusal, or right of first offer to purchase may also be included. Once you reach a pact - you and the owner will sign a lease, you’ll deposit the requested amounts and secure insurance. Now your company can live in the new location for the agreed upon period - let’s assume five years.

But during the lease term - something untoward occurs - a decline in sales, someone acquires your company, you decide to move your manufacturing function to China, or California imposes a huge levy on your product - which dictates a move out-of-state. You find yourself with a glut of space - for which you’ve committed! Now what? Well, those circumstances, dear readers create subleases.

A sublease is akin to a remnant sale at your favorite carpet retailer. A full roll of flooring is not available - so you get to pick from what’s left. Because a finite amount remains - little flexibility exists. If the scrap fits your area - great! You benefit. But if you’ve a larger area to cover - you’re hosed. Also, the smaller the amount of over run- the fewer takers. Now a price discount must be employed to liquidate. Ouch.

With a sublease - the primary motivation is to stem the bleeding. Excess space wastes rent payments. The thought of providing any concessions runs contrary to a desire to move-on. Consequently - a different dynamic unfolds compared to a direct lease. Plus - another layer of decision makers will be involved. Remember. A lease is in place - with a landlord and a tenant. Now the tenant becomes a de facto sub-landlord and you are the sub-tenant. All parties - master landlord, sub-landlord, and you - sub-tenant must agree and all must approve.

So with the descriptions of leases and subleases as a backdrop - how should you proceed?

Consider all your alternatives. If you need a ton of abated rent, extensive tenant improvements, or a 10 year term, a direct lease might be your best bet. Conversely - absent these requirements - a sublease can provide you with an adequate solution.

Seek counsel. Leases are complex. Subleases are uber complex. They are not for the squeamish. If your “landlord” stiffs the owner - your sublease is in jeopardy. You’ll need two sets of approvals. Plan on extended time frames to get all resolved. We recently encountered a sublease that took ninety days to get the nod!

Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.com.

Repairs During Escrow - Who Pays?

Buying a commercial building for your business to occupy is similar to acquiring a residence from which to raise your family. After all - your business will “live there” and grow for many years to come.

Most commercial deals are structured with a time frame to conduct due diligence - a fancy way of saying - figuring out if you want to complete the purchase. Generally - if something untoward is discovered during this contingency period - you can cancel the deal without penalty.

Some sellers are very organized and greet you with all manner of reports, studies, and opinions on the condition of title, roof, HVAC, office improvements, and environmental history. Others will simply allow you - as the buyer - access to snoop around on your own. By the way - the organized seller - the one with all the provided documents - has typically priced his offering in accordance with the report’s findings. Therefore - if you confirm the building needs a new roof - chances are the seller won’t pay. More on that in a bit.

A word here about purchasing a building in its “as is” condition. Normally a buyer relies upon his own investigation of the property’s condition - and commercial contracts are worded this way. So does this mean you must close a deal with a faulty wiring system? No. It just means the seller is not representing or warranting it or agreeing to mend.

So what happens if you realize the air conditioning has eclipsed its cooling life and blows about as hard as a defeated politician? Or - you discover - the roof is akin to a slice of Swiss cheese? Clearly, you have three choices - buy the building with all its faults and deal with the issues later, ask the seller to remedy, or walk away.

Let’s presume you love everything about the property and have decided you want to proceed - but feel its incumbent to ask for some repairs. Plan on the seller responding in one of the following ways.

He will tell you no. Certainly in the case of the organized seller - he preempted your request for repairs by investing in condition reports. He knew deficiencies existed and alerted you. Slim are your chances of convincing this seller otherwise. Conversely - if your seller was unaware - you may be able to extract some repair money. Make sure you fashion your ask with copies of your findings along with a reasonable dollar amount. What is unreasonable? Asking for a new roof on a forty year old building.

He will tell you yes. Bingo! However - the way in which the request is fulfilled is as important as the seller agreeing. A reduction in price is common. This makes a lender happy although he must re-work the loan percentages. Credits through escrow used to be the norm. Lenders now frown upon this as buyers supplemented their down payment - a no-no. Finally, a seller may simply offer to make the repairs. I’ve seen this approach work well when the dollar amounts are small or quick fixes are possible. Most sellers will not opt to do the refurbishments - however - as they don’t want the liability or the timing delays.

He will not respond. Similar to saying no - but akin to your parents answering “we will see.” So why would a seller not respond? Because a no is final. A non-response could be one of the following. He believes you’ll proceed anyway if he waits. Or - other parties to the transaction - IE the real estate professionals - might kick in. Maybe the seller wants to gauge the interest of bridesmaid buyers. Our AIR CRE Purchase and Sale Agreements allow for this “maybe” period with a ten day response requirement.

Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.com.