By Jones Osborn II

If you are not in the business of leasing office space on a regular basis, some of the customs and practices can be a little confusing. This can put you, the tenant, at a disadvantage, because the building owners and their brokers deal with these things every day. In order to help level the playing field, this memo reviews some of the basics so that you will be prepared when you start your search for office space.

Types of Leases. Most first class office space is leased on a "base year" or "expense stop" basis.

Under a "base year" lease, the first year's rent usually includes about everything -- utilities, taxes, insurance, janitorial services, repairs, and so on. This is usually referred to as a "full service" rate. However, that's just for the first year. After that, the building owner figures out how much the operating expenses of the building have increased over the base year. He then charges this increase back to the building's tenants in proportion to the amount of space each is leasing. This means that your rent will go up each year to cover increases in taxes, insurance, and other operating expenses of the building.

The "expense stop" lease is similar, except that instead of using a base year, all operating expenses over a stated amount are passed through to the tenant. For example, the expense stop might be $5.00 per square foot per year. If it costs $6.00 to operate the building, the tenants pay the other $1.00. If the expense stop figure is equal to the actual operating expense of the building in the first year of the lease, the base year lease and the expense stop lease are exactly the same. However, with an expense stop lease you need to verify the actual operating expenses of the building before you can figure out what the rent will really be.

Another kind of lease, which is sometimes used for smaller properties or for shorter term leases, is a "gross" lease. Under a gross lease, the total amount of rent is fixed in advance, and none of the operating expense increases are passed through to the tenant. In other words, it is a "full service" lease for its entire term.

Operating Expenses. If you are negotiating a lease with a base year or expense stop, carefully review the definition of "operating expenses," because this directly affects the amount of rent you will pay after the first year. Operating expenses typically include taxes, insurance, maintenance, repairs, janitorial fees, utilities, management fees, and most other miscellaneous expenses of operating a building. Items such as tenant improvement allowances, leasing commissions, interest, general corporate overhead, and the costs of expanding or adding to the building should be excluded from the definition of operating expenses. Any capital items included as an operating expense (such as the replacement of an air conditioning unit) should be amortized and charged to the tenants over the useful life of the improvement. Finally, the lease should allow reasonable audit rights so that you can periodically review the operating expense charges to ensure that they are correct.

Tenant Improvements. Leased space normally will have to be built out if the building is new, or modified if the building has been occupied by a prior tenant. These improvements are called "tenant improvements" or "TI's." Depending on the particular lease, they are either constructed by the landlord without regard to a dollar limitation, or paid for by the landlord pursuant to a tenant improvement allowance of a specified number of dollars per square foot. If the landlord is taking care of the tenant improvements, you should be sure that they are specified in detail so that the landlord will construct exactly the improvements you need and expect. If the improvements are to be constructed pursuant to a TI allowance from the landlord, you should consult construction experts to make sure that the allowance will be sufficient to pay the full cost of the necessary improvements. Somehow, TI's always seem to cost far more that one would imagine. Any cost over the TI allowance has to be paid by the tenant. In either case, tenant improvements can be a big dollar item and deserve a great deal of care and attention. Architects, construction specialists, or other experts should be retained to assist you.

Building Load. An understanding of the concept of the "load factor" is critical when shopping for office space. This is because office leases require the tenant to pay rent based on the number of "rentable square feet" leased by the tenant. However, the space actually occupied by the tenant, called the "useable" space, is only about 85 to 92% of the "rentable" space. This results from the fact that common lobbies, hallways, restrooms, storage rooms, and the like are allocated to the tenants in proportion to their usable space. This allocation of unoccupied space is called the "load." Therefore, in a building with a 10% load, a tenant leasing 10,000 square feet of useable space would actually being paying rent on 11,000 square feet, because he's paying for a share of the common areas. Clearly, it is important to know a building's load factor when comparing rents. Sometimes a higher quoted rate is actually cheaper than a lower one, depending on the load factor. The higher the load factor, the less useable space you are getting for your money.

Tenant's Share. A tenant's "share" is the amount of rentable space allocated to that particular tenant, as compared to all of the rentable space in the building. For example, a tenant leasing 30,000 square feet in a 100,000 foot building would have a 30% share. This figure is then used to allocate operating expense increases; that is, that particular tenant would have to pay 30% of all increases in operating expenses over the base year. The tenant's share of operating expenses is unrelated to the building's load factor, although these two figures are sometimes confused by tenants.

Parking. You should make sure that sufficient reserved spaces are assigned to you to adequately handle your customers and employees. If the building does not assign reserved spaces, will not assign enough reserved spaces to meet all your parking needs, or charges more for them than you want to pay, it is important to investigate the building to make sure that the building, when fully leased, will have sufficient unreserved parking available to accommodate all tenants. This may require a sophisticated analysis of the type of tenants the building has or is likely to attract, because some uses, such as call centers, generate a much higher parking burden than general office uses. Nothing is worse than signing a long term lease and then learning that you will face a continual shortage of parking.

ADA. The landlord should warrant that the building and the leased space will comply with the Americans with Disabilities Act upon the commencement of the lease. Alterations to meet these requirements can be extremely costly.

Term and Options. Most office leases run from five to ten years. Often the tenant will have one or more options to extend for additional terms. Frequently, the landlord will not be willing to fix the rent for the option period, preferring that it be set at "market rates." This is acceptable to most tenants; however, the tenant should be sure that there is a fair way to establish market rent, perhaps by arbitration. It should never be left to the landlord's discretion.

Signage. Don't forget signage. If you need prominent signage, you should negotiate specific signage rights in the lease.

Alterations. Leases typically provide that the tenant may not make alterations to the premises without the landlord's advance written consent, which may not be unreasonably withheld. Most leases also provide that any such alterations must be removed upon the expiration of the lease if so requested by the landlord. This is not unreasonable; however, you should request a provision requiring the landlord to give notice, when approving alterations, whether it will require removal at the termination of the lease. This allows you to determine in advance whether you wish to incur the expense of the alteration by knowing whether it will have to be removed upon termination.

Subleases and Assignments. Leases almost always require the landlord's approval to a sublease or assignment, not to be unreasonably withheld. However, some leases also define an assignment as any transfer of control, such as the transfer of stock by shareholders, merger, and so on. The latter provisions should not be accepted if your company is public or has numerous shareholders, or if it might be considered a target for an acquisition or merger. On the other hand, where the business is owned by a single shareholder or is a family run enterprise, it may be legitimate for the landlord to have the right to approve changes in control.

Default Provisions. Every office lease specifies a number of events that constitute a default by the tenant, including the failure to pay rent. You should negotiate for a provision stating that the failure to pay rent or any other failure to perform under the lease will not become a default until you have been given reasonable written notice and an opportunity to cure. This will avoid the risk that the lease could be terminated or other sanctions imposed if the rent is not paid due to inadvertence, problems with the mail, and so on. Generally, five to ten days' written notice is considered reasonable for monetary defaults, and 30 days for non-monetary defaults.

Expansion Rights. If you believe that your business might expand during the term of the lease, you may wish to negotiate for expansion rights for adjacent space, or perhaps a right of first refusal when additional space becomes available in the building. Although useful, expansion rights can be difficult to negotiate, and can normally be obtained only by major tenants.

Relocation Rights. Many leases contain a relocation provision which allows the landlord to relocate the tenant to different space within the same building, usually at the landlord's expense. Although this is very convenient for the landlord when trying to assemble blocks of space for a new tenant, it is a tremendous inconvenience for the tenant. It should be resisted if at all possible. The larger tenants are usually able to have this provision deleted from their lease although the landlord may hold firm for smaller tenants or in a tight market.

Nondisturbance Agreement. You should insist that the landlord provide a nondisturbance and attornment agreement from the building's lender. This is a document stating that the lender will honor the tenant's lease should it ever foreclose on the building. Without such an agreement, the lender would be free to terminate your lease or increase the rent after completing a foreclosure, and might well do so if rents have increased since you signed your lease.

Special Requirements. Before beginning your search for new space, make a list of your special requirements. Do you require special air conditioning for computer equipment? Do you have large file storage requirements or a library that will require above-standard load bearing capacity for the floors? Do you need heating and cooling after normal business hours? (If so, be sure to ask about the cost per hour). Do you have special internet or phone line requirements? You can save a lot of time and avoid catastrophic mistakes by carefully thinking through your requirements in advance and then making sure that they are adequately addressed in the lease.

Conclusion. The modern office lease is a complex and lengthy document, and can represent a large claim on your cash flow over a number of years. Experienced brokerage and legal representation is very important. The "standard leases" tendered by landlords are often one-sided documents which put the tenant at a material disadvantage. Experienced help can help you avoid the hidden pitfalls and to obtain a fair lease.