In Week 1 of my Foundations of Real Estate Finance class at Georgetown, we covered commercial leases, and discussed what Professor Linneman states is one of the most important terms in a lease, which might not be apparent to someone who is new to the world of real estate leases. Other than base rent, escalations and term, he emphasizes that the use of the space is critical to define. He used an extreme example to illustrate how a multi-tenant retail center could be economically destroyed by the introduction of a slaughterhouse into the in-line tenant mix. The class seemed to get it.
Leases absolutely must stipulate the allowed use of the space (e.g., office, retail sales, manufacturing, health clinic), and do so in a detailed manner, also stating what activities are not allowed. For that matter, from the landlord’s perspective, they should also stipulate that the landlord has the right to buy out the tenant at certain milestones. This allows the landlord the flexibility to sell the property should they wish to do so by being able to terminate leases (at a price).
I spoke with a colleague recently who relayed a story about a retail center that was in a location ripe for mixed-use development, and the anguish of the property’s owner in not being able to sell because a single tenant out of a dozen whose long-term lease did not provide for any landlord buyout. Who was the tenant? A butcher, one whose lease also did not prevent him from slaughtering on the premises (which he did, every day). So even if he was willing to be put back in place into a newly developed center, he would be able to slaughter on site. (There was a recent NY Times article that discusses a similarly grisly situation.)
As cliche as it sounds, the devil is in the details. Proceed with extreme caution when signing leases, and ask the “obvious” questions that you would not otherwise ask for the fear of sounding “stupid”. You’ll be glad you did.
What are the “obvious” items in a lease negotiation that should never be overlooked?