OK, so you have a good broker with coworking experience, you’ve brushed up on your commercial real estate lingo, and you have your checklist of top 10 things top things to look for in your coworking space. If you’ve started looking at spaces, it’s time to understand how the lease negotiation process works.
First, make sure you have a good real estate attorney ready to spring into action. You don’t want to do this process without a broker and you don’t want to do this without a real estate attorney. Yes, you will have to pay the attorney out-of-pocket. I promise you that the downside risks of not using one is greater than what you initially fork over.
Get a strong referral from someone in your network for a real estate attorney. Try to get one that has some experience in flexible office so that they understand your unique needs.
How the lease process works:
Once you (the lessee) finds a space that requires the least number of trade-offs—likely one in your particular market—the next step is to execute a letter of intent or “LOI” for short.
Here is a quick overview of a letter of intent. Find more details here at nolo.com:
“A letter of intent may be written by the landlord or the landlord’s lawyer, or by you or your lawyer. The letter summarizes key issues that you’ve already discussed, such as the issues mentioned above, and may mention other aspects of the lease negotiations, such as a timeline for improvement work and moving in. The letter can be legally binding or nonbinding, depending on how it’s written and how you and the landlord treat it. In short, the letter of intent may be a mini-lease or a simple road map for future negotiations.”
The LOI may include items such as:
- Rent rate
- Rent increases and timeline
- Lease period
- Lease type (i.e, full service or triple net)
- Free rent period
- Tenant Improvement (TI) dollars
- Number of parking spots included
- Real estate taxes and operating expenses
- Security deposit
- Use of space
In order to prepare the LOI, the broker will look for comparable spaces in the market to propose a lease rate for the space, as well as the market rate for TI contributions.
Once the first LOI/proposal is submitted by the lessee’s broker, the landlord will respond. Once the landlord responds, you are negotiating in good faith which means that you, the lessee, should not be negotiating for other space with another landlord and in turn, the landlord should not be negotiating with another lessee over the same space.
After these general terms in the LOI are agreed to, the lease process begins. At this point, a sophisticated landlord will likely have a standard template they prefer and will prepare it to send to the lessee. This may not be the case. The real estate industry is shockingly unstandardized and you will find the time and dollars spent on lease negotiations and real estate attorneys completely mind-blowing. While you will have to take up meditating to deal with your stress levels, there is an upside: you will say “This is why people join coworking spaces. Who in their right mind would ever sign a commercial lease!?!” And you will find the energy to get through the process.
The lease will be a substantial document and negotiations may take months…which again makes no economic sense. The brokers want to get paid. The landlords likely have space sitting empty with no rental income. One explanation could be due to the real estate attorneys billing hours the longer the process takes. But I generally don’t think they drive the drawn-out timeline. It seems like a lot of minor delays that add up to major delays:
- It takes longer than you think to get three general contractors to give you bids so that you can negotiate on TI
- Landlord is working on multiple leases, takes a week to turn your review around
- Real estate attorney is on vacation
- Your Broker is on vacation
- You take a week to decide how to respond to a term that may be a deal-breaker for you
- Your real estate attorney goes on vacation
- Someone else gets really interested in the space and the landlord starts to play hardball on some of the terms you thought you were aligned on
- Landlord gets a tax notice and increases the CAM
- Landlord’s broker goes on vacation
- Someone uncovers a new regulation that needs addressing with any new construction. Totally changes the cost of the buildout.
- Someone has a death in the family.
…and it’s 9 months later and you’re still working on the lease.
Financial Review of the Lessee
The signing of the lease will be dependent on the landlord’s review of the lesse’s financial application. The landlord has a very subjective requirement for the level of assets that he needs to see on the lesse’s personal balance sheet to be comfortable with you taking on this liability.
Which brings us to another key topic: The Personal Guarantee.
The Personal Guarantee
There is wide debate over whether or not you can avoid this. In my experience, it’ not that easy to avoid – every landlord would prefer to include one in the lease. This essentially means that if your business entity can’t pay the rent, then your personal assets (for example, your home), may be seized to pay the rent. Some suggest that landlords will not spend the attorney fees to actually go through with it, but some certainly will.
It recently came to my attention that there are markets, for example, Milwaukee, WI, where personal guarantees are not standard. So you may be operating in a market where this isn’t such an issue.
Your landlord will require a security deposit that he can hold through the length of the lease. The deposit amount can be equal to two months of rent. The deposit can be more substantial in major metro markets or for lessees with no prior rental history or business credit. This is another point at which you ask “why would any small business ever want to get involved in a commercial lease?” Be sure to ask about this number early in the process so that you have an understanding of how it will impact your start-up costs.
Your broker will help you attempt to negotiate a burn-off of your security deposit. You may not be successful but you should ask if the deposit is substantial. You may be able to “earn back” the deposit with consistent, on-time rent payments.
Negotiation levers and notes
Know what’s important to you given your start-up capital situation.
- Landlord funding the TI (construction) vs. you fronting the TI then paying a reduced rental rate for X number of months. This is the difference between you financing the construction and the landlord financing the construction.
- Make sure that your business model still works in later years of the lease when the rental rate has gone through several increases.
- As mentioned in a previous post, make sure you ask for the signage that you need to help your members/guests find your entrance
- If codes change, and something like lighting needs an update, negotiate who will be responsible – you or the landlord
- Make sure the lease language allows you to run your business. Make sure your real estate attorney understands your business model and adjusts the language in the sub-leasing section so that you can license space to your members/clients and any license will not be viewed as a sublease, needing approval by the landlord.
The lease process can be a challenge but if you prepare mentally for the process, hopefully it’ll be a little easier. Good luck!