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Three Things Every Tenant Must Understand When Negotiating a Lease

From left to right: David Wensley, Rob Bello and Tucker Hughes.

By Tucker Hughes

Last month, Hughes Marino had the honor of serving on a panel for the Orange County Bar Association discussing common pitfalls to avoid when leasing commercial space. Together with Hughes Marino’s in-house general counsel, Rob Bello, and David Wensley, Partner at Cox, Castle & Nicholson, we covered multiple topics, surrounding how tenants can best protect themselves in an appreciating market.

Three of the major points that we discussed in front of the audience of roughly 80 attorneys included: Exercising expansion rights, the importance of understanding lease language in a competitive market, and why it’s crucial to make sure that tenants secure preferential operating expense treatment, in addition to a 2016 base year when it comes to negotiating their lease’s operating expense pass throughs.

Here’s a brief overview of each of these vital areas:

Exercising Expansion Rights

Since the passing of Title 24, companies seeking to expand their existing office into contiguous space need to be aware that, in doing so, they may trigger costly Title 24 energy efficiency requirements. For example, a company looking to expand its current 5,000 square foot office to include an additional 2,000 square feet will now be responsible for ensuring that all 7,000 square feet are compliant with Title 24. At the same time, most landlords are only willing to offer a tenant improvement allowance for the newly acquired space. As tenant representatives, we advised our audience to ensure that the language in the lease directly addresses this type of situation, so as to prevent the tenant from having to foot the bill for all Title 24 upgrades required by law.

Operating Expenses

Most office leases in Orange County operate based on a full service rent structure. This means that all of the operating expenses for the base year of the lease are accounted for in their monthly rent. Beyond the base year though, the tenant is responsible for their proportionate share of the building’s increase in operating expenses. This means that having a higher base year is very beneficial, and that tenants need to seek opportunities to limit the forthcoming increases in the building’s expenses in future years.

While a tenant can’t control property taxes or prevent insurance premiums from escalating, there are steps that tenants can take to minimize their out of pocket costs related to pass throughs. One of the most important steps a tenant can take to reduce their risk is ensuring that their Base Year extends forward to the following calendar year so they have a full 12 months to establish the cost basis of expenses. Some owners push back hard on this item, in which case tenants should shift their focus towards an exclusion of paying operating expenses for the first 12 to 18 months of the lease.

Tenants should also ensure that the building’s expenses are “consistently applied” from year to year to prevent hefty new expenses from appearing beyond the base year that are passed on directly from the landlord. A typical rule of thumb is that the landlord can add reasonable expenses so long as they adjust the underlying expenses in the base year up accordingly.

Understanding Lease Language

The market in Orange County has become so competitive, that it is vital that businesses looking to lease space understand what items need to be included in a letter of intent in order to make it into the ultimately binding lease document. Spending time requesting items that are frequently discussed and negotiated in the lease document delays the critical path, exposing the client to unnecessary risk from third parties who may be interested in leasing the same space. Knowing exactly what must be in the letter of intent in order to make your offer the most attractive is also crucial.

It is especially important for attorneys who represent companies to understand these potential pitfalls so they can advise their clients on how to avoid them during an appreciating commercial market. That’s why it was an honor for me to take part in this worthwhile discussion with some of Orange County’s top legal professionals. I know that I speak for everyone at Hughes Marino when I say that we collectively embrace any and all opportunities to make sure that tenants are as informed as possible before signing away their rights.

Tucker Hughes is managing director at Hughes Marino, an award-winning commercial real estate firm with offices across the nation. As head of Hughes Marino’s Orange County and Los Angeles offices, Tucker specializes in tenant representation and building purchases throughout Southern California. Tucker makes frequent media appearances to speak on the future of commercial real estate, and is also a regular columnist for Entrepreneur.com. Contact Tucker at 1-844-662-6635 or tucker@hughesmarino.com.

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