Inside look - the anatomy of a lease deal - part 1
Prepare yourself for a not-so-often-seen look into the inner negotiations of a commercial lease transaction currently underway.
You may say I am crazy for disclosing this private information especially while we are in the middle of negotiating. I am not using names or addresses and am tweaking the terms a bit because I am not crazy and I need to protect my client’s interest.
I am representing the landlord of a 10,000 square foot office space being pursued by a medical office tenant. This is considered a re-tenanting of an office space into a medical office space and entails obtaining approval by the city as well as requiring extensive improvements.
The terms are for a ten year lease with two, five year options to renew at a $1.90 per square foot (psf), triple-net. The offering price is $2.00 psf, triple-net so we are close. Remember, triple-net is the reimbursement of the operating expenses by the tenant to the landlord.
The tenant is estimating its improvement costs close to $250 psf. This comes to $2.5M to convert the space into an office for medical use! But, as you can imagine the infrastructure for a medical office is much more intensive than a regular office space.
So, the tenant is asking the landlord to share in some of the cost, called a tenant improvement allowance, of fifty dollars psf or $500,000. The tenant is asking this amount, plus 4 percent interest, be amortized over the ten year term of the lease as a rent reduction. Why is the tenant requesting interest? Think of the cost of funds, you could have $500,000 in a mutual fund earning interest.
If you calculate the actual reduction in rent this comes to $5,303 per month in an amortized reimbursement over ten years. If you divide this monthly amount by the square feet leased it comes to a monthly rent reduction of $0.53 psf. So, their net rent will be a $1.37 psf plus the triple-net reimbursement.
A couple of additional terms, the landlord wants annual increases in the rent of 3 percent per year including the years they choose to exercise their option for extending the lease. The tenant wants an option to cancel the lease after five years reimbursing the landlord any unamortized rent reduction for the tenant improvement allowance.
Lastly, because of the amount of time needed to gain approval for the type of use and to complete the build-out the tenant is asking for six months of free rent from when they gain possession of the premises to when they actually open their doors.
Complicated? This is only the half of it. In my next article I am going to tell how we completed negotiations (which is still unknown to me as of this writing), the use permit process, insurance issues and property taxes.