Office Leases: Lease Negotiation Points, What Makes for a Good Landlord, What Does "Base Year" Mean on a Lease

In this episode we cover what does the base year mean in office leasing, what are specific things that startups want to negotiate on a lease, what happens when a startup goes out of business, LOI’s, lease negotiation & TI’s (also called lease concessions), and lastly, what makes for a good office landlord.



You can read this episode here: https://montecarlorei.com/office-leases-lease-negotiation-points-what-makes-for-a-good-landlord-what-does-base-year-mean-on-a-lease/



For offices, are the leases typically NNN?

No. It's typically what's called a "full service lease" where you pay your rent, and it's pretty much in all in rent. The landlord covers the utilities, the janitorial,  the operating expenses, and real estate taxes. The way that it works is you get what's called a base year. So let's say we completed our lease in 2019 and we do a three year term. You get a "base year" and 2019 is your first year, you don't need to pay any real estate taxes and operating expenses. But in the following year you are responsible for paying your proportionate share of the increase in operating expenses and real estate taxes. So let's use round numbers, for example let's say that you occupied 10% of a building. The operating expense in real estate taxes were $100 in 2019 and they went up to $200 in 2020, a $100 increase. All you need to pay is your proportionate share of $100, in this case $10. But as you do a long term lease, 7-10 years, it's growing every year, and that number can become significant. So a lot of companies will renegotiate their lease, they will do what's called an extension, or they'll expand and renegotiate the lease to get a brand new base year so that they don't have to incur those costs.

Has it ever happened that a startup went out of business, and what happened to that contract? What are the recourses for the landlord? 

They go into what’s called a default and the landlord eventually ends up needing to collect their money. This situation has come up numerous times and what we do is find a new tenant to sublease the space. We market it for sublease, and once you come to an agreement on terms, the landlord will say “Okay, instead of subleasing from this company who has gone bankrupt, we’ll wrap up that lease and do a new direct deal with this new tenant”. So we’re able to bring a new tenant into the space and, by doing that, cut our client out of any rent responsibility moving forward.



What are some specific things that startups want to negotiate in a lease that we haven't covered yet?

The few things that we've covered so far are the big items such as rent, term, free rent, tenant improvement allowance, and the security deposit. Things we haven't talked about yet are: let's say a landlord is forcing us into a five year deal, but we know we're not going to be able to make it for the full five years. We try to negotiate a termination option where after three years we can terminate with no penalty, or a very small penalty such as two months rent. Another item is sublease rights, a landlord will generally give you the right to sublease, but any profit that you get for that sublease is split 50-50 between the tenant and the landlord since they want to discourage tenants to take space and sublease for a profit. When you're in rapid expansion mode we try to negotiate what's called a right of first refusal, where if a space becomes available in the building, the landlord is required to present it to the startup first at a fair market value.



Reuben Torenberg

[email protected]



Steffany's Linkedin: https://www.linkedin.com/in/steffbold/

---

Support this podcast:

In this episode we cover what does the base year mean in office leasing, what are specific things that startups want to negotiate on a lease, what happens when a startup goes out of business, LOI’s, lease negotiation & TI’s (also called lease concessions), and lastly, what makes for a good office landlord.



You can read this episode here: https://montecarlorei.com/office-leases-lease-negotiation-points-what-makes-for-a-good-landlord-what-does-base-year-mean-on-a-lease/



For offices, are the leases typically NNN?

No. It's typically what's called a "full service lease" where you pay your rent, and it's pretty much in all in rent. The landlord covers the utilities, the janitorial,  the operating expenses, and real estate taxes. The way that it works is you get what's called a base year. So let's say we completed our lease in 2019 and we do a three year term. You get a "base year" and 2019 is your first year, you don't need to pay any real estate taxes and operating expenses. But in the following year you are responsible for paying your proportionate share of the increase in operating expenses and real estate taxes. So let's use round numbers, for example let's say that you occupied 10% of a building. The operating expense in real estate taxes were $100 in 2019 and they went up to $200 in 2020, a $100 increase. All you need to pay is your proportionate share of $100, in this case $10. But as you do a long term lease, 7-10 years, it's growing every year, and that number can become significant. So a lot of companies will renegotiate their lease, they will do what's called an extension, or they'll expand and renegotiate the lease to get a brand new base year so that they don't have to incur those costs.

Has it ever happened that a startup went out of business, and what happened to that contract? What are the recourses for the landlord? 

They go into what’s called a default and the landlord eventually ends up needing to collect their money. This situation has come up numerous times and what we do is find a new tenant to sublease the space. We market it for sublease, and once you come to an agreement on terms, the landlord will say “Okay, instead of subleasing from this company who has gone bankrupt, we’ll wrap up that lease and do a new direct deal with this new tenant”. So we’re able to bring a new tenant into the space and, by doing that, cut our client out of any rent responsibility moving forward.



What are some specific things that startups want to negotiate in a lease that we haven't covered yet?

The few things that we've covered so far are the big items such as rent, term, free rent, tenant improvement allowance, and the security deposit. Things we haven't talked about yet are: let's say a landlord is forcing us into a five year deal, but we know we're not going to be able to make it for the full five years. We try to negotiate a termination option where after three years we can terminate with no penalty, or a very small penalty such as two months rent. Another item is sublease rights, a landlord will generally give you the right to sublease, but any profit that you get for that sublease is split 50-50 between the tenant and the landlord since they want to discourage tenants to take space and sublease for a profit. When you're in rapid expansion mode we try to negotiate what's called a right of first refusal, where if a space becomes available in the building, the landlord is required to present it to the startup first at a fair market value.



Reuben Torenberg

[email protected]



Steffany's Linkedin: https://www.linkedin.com/in/steffbold/

---

Support this podcast: https://podcasters.spotify.com/pod/show/best-commercial-retail-real-estate-investing-advice-ever/support