Commercial Lease Negotiations – Don’t Forget the Letter of Intent

When negotiating  commercial  leases, whether for retail, office, or industrial space, landlords and tenants often want to quickly strike the business deal and move on to the next steps.  Those business terms will usually be set out in the agreed upon letter of intent, or “LOI” – essentially, an agreement to enter into a lease agreement.  Even though most LOIs contain (and should contain) clear language that they are not binding contracts, once the parties have agreed upon the key terms in an LOI, the terms are often viewed by the parties as final, and there is usually strong resistance (and often outright refusal) to change those terms.

To pave the way for efficient lease negotiations, and to avoid miscommunications that could derail negotiations, the parties should be clear on certain key terms that will be included in the lease.  For instance:

  • What is the term? If any extension options will be available to the tenant, they should be included in the LOI, including when the tenant will be required to exercise the extension option.  If the tenant wants an early termination right, or rights to expand into additional space, that should also be included in the LOI.
  • What is the rent? Is it a “gross rent” deal (i.e., all costs and expenses are included in the rental amount) or a “net lease” (where, in addition to the base rent, tenant is required to reimburse the landlord for its share of maintenance expenses, taxes, and insurance)?
  • How, and when, will the space be delivered? Will tenant take the space as-is, on a date certain?  Or will landlord be modifying the space to suit the tenant’s needs?  If so, what is the timeframe for landlord to complete that work and deliver the space to tenant?  If the tenant is leaving an existing space and counting on moving to the new space when their current lease is up, landlord and tenant should be clear and on the same page about the deadline for delivery of the completed space.
  • What improvements will the tenant make in the space, and is landlord contributing any funds to that work? Tenants often want to be in control of the improvements to the space, and in those instances, the landlord will often provide a tenant improvement budget (known as a “TI Allowance”) for the tenant to perform that work.  If a TI Allowance will be provided, the LOI should be clear on the amount, when it will be paid, and what it can be used for.  For instance, will it apply to hard costs only, like remodeling, or can a portion be used for furniture, or even moving allowances?
  • What security will be required? A deposit?  A personal guaranty?  When considering a tenant for a commercial space, the landlord will conduct review of the tenant’s financial statements.  From there, the landlord will make a risk analysis to determine whether a deposit will be required, and whether a personal guaranty will be required.  If the landlord requires a deposit or a guaranty, the tenant may be able to negotiate a reduction on the deposit, or a termination of the guaranty, after performing under the lease with no defaults for a certain period of time.

These are just a few of the key provisions that are addressed in LOIs, but all LOIs and leases have nuances that make them unique.  Both landlords and tenants should carefully consider the terms they are agreeing to in an LOI before they sign and, likewise, carefully review the terms of the lease to make sure it is consistent with the agreed upon LOI and addresses each parties’ business needs.

Noelle Riccardella is an attorney in Williams Weese Pepple & Ferguson’s Real Estate group.

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