What Are My Top Five Most Important Clauses In a Commercial Lease?

I started my career in the commercial real estate industry back in 1986, and I spent the better part of two decades in the brokerage and corporate advisory end of the business. I guess you could say I’m still in the commercial real estate business, except now I’m an advisor on the lending side, helping small businesses with things like evaluating different buildings, analyzing business terms, etc.  And I still review a lot of leases, offering comments and suggestions for my clients to share with their real estate counsel.  

Back when I worked in the brokerage business - and this is still very true today - there was an old saying that, “Every clause in a lease has a potential dollar sign next to it.”  In other words, you have to understand what you’re signing because other than the obvious direct costs (i.e. rent, expenses, etc.), the other clauses in the lease can have an indirect and potentially greater cost to the business.  

I was a financial analyst in the early days of my career, which is where I learned the in’s and out’s of commercial leases.  I’ve literally read thousands of leases, for all different property types.  While each property type has certain nuances, the basic structure of a commercial lease hasn’t really changed all that much over the years.  Again, every clause in a lease is important, but what follows are five clauses in a commercial lease, aside from the basic business terms, that I believe are of particular importance (in no particular order).  

1. Sublease / assignment

I work with a lot of businesses that are just getting started.  One of the things I ask new entrepreneurs is, "What's your exit strategy?"  It may seem like a silly question to ask before the business is even up and running, but knowing the end goal is helpful in terms of crafting a strategy to get you 'from here to there'.  The same principle is true in commercial leasing.  You have to think ahead and anticipate potentialities.  Exiting the space, or even selling the business, should you need or want to, is something you need to think about.  Even if you think you're going to remain in the space forever (in which case, you should probably be looking at buying the building), it's nice to have flexibility in case your vision changes.  This is where the sublease / assignment clause comes in.  Most leases permit sublease / assignment, with the landlord's consent.  "Which shall not be unreasonably withheld or delayed", is the trailing language you want to see included with this provision.  

2. Renewal option

Perhaps you do want to continue operating in the space beyond the expiration of the base term.  In which case, you're going to want to make sure the lease contains an option to renew.   Typically, the rental rate is at the then-current 'market' rate, which requires the parties to mutually agree on (i.e. it's subject to negotiation).  What you should pay close attention to in this clause is the notification requirement, which includes the time period to notify the landlord of your intent, and the manner of notification (ex: "in writing, via certified mail, no later than six months prior to the expiration of the lease term").  Sometimes you'll see a 'time is of the essence' clause in the lease, which means the notification date is firm.  A lot of businesses are lax on this requirement, but if the landlord wants the space back, for whatever reason (ex: a larger, contiguous tenant wants to expand their footprint), and you haven’t provided proper notification, pack your bags 'cause you're leaving!  And if you don't leave in a timely manner, the 'holdover' penalty, not including potential consequential damages, could be 200% of the last rent.  

3. Quiet enjoyment

I was working with a particular client about six years ago who had signed a lease for a new spa business (I came in after the lease was executed).  Again, the space was going to be used for a spa, where the atmosphere of the business was supposed to be peaceful and tranquil.  Upstairs was a bar that had leaky beverage lines running through my client's ceiling, and a few doors down was an exercise studio that played music at a nightclub level.  Not exactly what you'd call 'quiet enjoyment', right!?!  Thankfully, the landlord was very responsive to the problems, after my client's attorney invoked the 'quiet enjoyment' clause (asserting the lease to be in technical default), and the disruptions were eventually mitigated.  I guess there's two lessons here.  The first is, do your due diligence.  If you need 'quiet' space, think about your neighbors.  And second, make sure you have protection in the lease against disruptions.  

4. Tenant improvements

A lot of the businesses I work with occupy retail space.  The way it usually works in retail leasing is that the landlord is expected to deliver the space in what's called  'plain vanilla box' (PVB) condition, meaning, the infrastructure and basic finishes are already in place, whereby the tenant could move their belongings in and open for business.  If the tenant wants to upgrade from PVB (with the landlord's consent), that's on their dime.  However, PVB isn't always the reality with a lot of spaces, particularly for smaller spaces in class 'C' or 'D' buildings.  I've seen complete shell space with no plumbing, wiring, or HVAC beyond the building trunk lines.  This always begs the question, "What's the tenant's versus the landlord's responsibility?"  In other words, who's going to pay for it?  Once again, everything is negotiable, and it may be financially prudent for the tenant to take on more construction responsibility than what is typical (ex: in exchange for a greatly reduced rent).  But understand this: money is tight for most small businesses.  As such, why are you spending your scarce money fixing up the landlord's building?  More specifically, why are you making improvements to the building that are likely going to survive long past your tenancy?  In this scenario, you're functioning as both a tenant and a lender.  My advice is to stay out of the real estate financing business and stick to paying for just your above-standard improvements.  Or better yet, if you can, get the landlord to pay for it and amortize it into your rental rate.  In other words, the landlord is the lessor and the financier.  

5. Guaranty

I'm sure you've heard the advice that you should set up a separate legal entity (ex: an LLC) to protect yourself from having business obligations comingled with your personal life.  It's great advice, except for one thing - the principle of limited liability doesn't apply to small businesses that borrow money.  And leasing is a form of borrowing money; it's no different than a loan.  The business is always going to be the primary guarantor for large financial obligations, but small businesses may also be required (and usually are) to provide a personal guaranty.  That means if the business can't pay the costs of the lease, for whatever reason, the business owner will dip into his/her personal checkbook to make the payment.  Worst case scenario, the business declares bankruptcy.  In that case, the business owner has probably also exhausted their personal funds, whereby the landlord most likely isn't going to be made whole.  I'm thinking of another old saying, which is, "You can't get blood from a stone."  For this reason, you should expect the landlord to evaluate your business (i.e. its viability and feasibility) just like any sophisticated money partner would.  

A few final thoughts…

Real estate is a cyclical business, and the market dynamics of supply and demand change regularly.  Sometimes it's a tenant's market and other times it's a landlord's market.  Depending on the particular negotiating climate, structuring a favorable lease for the tenant can sometimes be a challenge.  This is where an experienced real estate broker can be valuable.  They can advise you on the terms and conditions you will likely be able to achieve, given your degree of negotiating leverage, which by the way, can vary by individual property.  The broker can also advise you on the quality of the landlord.  There are 'good' landlords and there are 'bad' landlords.  The latter can be tremendously disruptive to a tenant's business.  

Let me go back to something I said at the beginning of this post, which is, "Every clause in a lease has a potential dollar sign next to it."  As such, this is not a 'do-it-yourself' function.  An experienced real estate attorney can be worth every dollar of their fee.  Every lease is different, and the potential implications of the language contained within the lease may not always be obvious.  Lawyers go to law school and are trained on how to anticipate and mitigate risk.  Again (this is worthy of repeating), the risks contained within a commercial lease can be significant.  A bad lease can be catastrophic to a small business, so don't try to do it yourself.  

"What about generative AI?", you ask.  Good question!  If you want to feed the lease into an AI program, go right ahead.  You can ask it to explain any terms or provisions you're not familiar with.  It can be a very helpful educational tool, which I'm all in favor of.  Here’s my final old saying: "Trust, but verify."  As much as I love gen-AI, I wouldn't trust it entirely.  I'd still have an experienced attorney who specializes in commercial leases give the final draft the 'once-over'.  "Don't be penny wise and pound foolish."  Oops, I snuck another one in on you!  

The opinions and viewpoints expressed herein are those of the author.  Community Investment Corporation makes no warranties or representations as to the accuracy or forward-looking guidance of the material.  Readers are encouraged to conduct their own, independent research and consult professional advisors before making any decisions.  Oh, and one other thing - none of this was written by AI.