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8 Red Flags To Look for Before Signing a Lease Agreement for Your Business

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8 Red Flags To Look for Before Signing a Lease Agreement for Your Business

Red flags in leasing agreements and how to avoid them.

Steve Zimmerman, Founder, Principal Broker and CEO of Restaurant Realty Company

Before you sign a commercial lease for a business or franchise agreement, it’s imperative that you review it carefully. Understanding lease terms, including tenant responsibilities and restrictions, can have a significant impact on your bottom line and ability to operate successfully.

Furthermore, certain legal clauses can threaten your future tenancy, including your ability to sell your business. Several potential red flags to look out for include: Use Clause Restrictions, Demolition Clauses, Relocation Clauses, and Non-disturbance Clauses. 

1. Demolition clauses give landlords the flexibility to terminate the lease.

Oftentimes, landlords of older buildings add demolition clauses so they can take advantage of redevelopment opportunities in their community. A demolition clause gives landlords the flexibility to notify the tenant that their lease is terminated, and force them to vacate the premises, usually with six months of notification or less. 

What to do: The best option is to not sign anything with a demolition clause. If you still want to move forward, make sure that the landlord is required to give you at least several years advance notice so you can recoup your investment. Also, the landlord should pay the tenant their unamortized portion of their leasehold investment. 

2. Recapture clauses can impact business value when the owner tries to sell.

If the tenant is selling the business and requests to have the lease assigned to the buyer, under the recapture clause, the landlord has the right to retain possession of the property prior to the expiration of the lease. A business’s value is directly tied to it’s lease and other operating expenses. Without the existing lease in place, the business’s value is not longer valid.

What to do: If at all possible, do not sign a lease with a recapture provision. If you do, ask the landlord to state in the lease that the issue of consent for reassignment be dealt with on a case by case basis. In some cases, whereas the tenant requests a reassignment and the landlord intends to exercise their recapture provision, the tenant has the option to remove their request for reassignment and continue to maintain possession of the premises.

3. Use clauses can restrict how you do business - and what you can and can’t do

Use clauses force company owners to stay locked into a single business type. For example, if you run a restaurant, this section can prevent you from changing your concept, name, menu or focus. Variations of use clauses are common in leases for shopping centers and plazas. This type of clause damages your ability to adapt to market conditions. Depending on the terms, it can be nearly impossible for you to innovate.

What to do: If a commercial lease has a use clause, make sure it gives you ample wiggle room for changes. Don’t sacrifice your ability to innovate or change your concept.

4. Lease options personal to assignor can’t be assumed by a business buyer.

If the lease options are “Personal to the Assignor”, and the owner wants to sell their business, their lease options are applicable to them alone - not the buyer. This can cause major problems when the seller tries to transfer the existing lease.

What to do: Before you sign the lease, confirm that the options are not personal. Also, confirm with your landlord, that if you should sell your business during the lease term, whether or not a new long-term lease with similar terms and conditions will be offered to the buyer.

5. Real estate tax clauses with no cap limits can leave you vulnerable to tax increases.

It’s quite common for leases to include a real estate tax clause, whereas the tenant is expected to pay a portion of the taxes, relative to the amount of space they occupy. If the building is sold during the tenancy for a higher price, its taxes will be reassessed. In the event of a tax increase, if the lease does not include a cap limit on real estate tax, the tax increase will be passed along to the tenant. A substantial tax increase could force a tenant out of business. 

What to do: Make sure your lease agreement states that real estate tax increases are capped at a comfortable level - even the property is sold to a new owner. Not all lease agreements require tenants to pay real estate taxes, but many do. 

6. Without a non-disturbance clause, a business could be forced out if the landlord loses the property to foreclosure.

A non-disturbance clause protects the tenant from the mortgagor. It ensures the lease agreement between the tenant and the landlord will continue if the landlord goes bankrupt and goes into foreclosure. Without a non-disturbance clause, the tenant could lose the space, including any investments they made in renovations. 

What to do: Look for a non-disturbance clause that guarantees your company’s continued usage of the property under the current lease in the case of bankruptcy or foreclosure. If you don’t see one, ask the landlord to add it.

7. Relocation clauses can lead to a business being reassigned to an inferior location.

If your business is located within a multi-tenant property such as a shopping center, a relocation clause gives the landlord the right to move your business to another space within the property. The new space could hurt business in a number of ways, such as poor visibility, less parking, or simply less foot traffic. A poor location can spell the end of a business. Furthermore, a business’s value is tied to its location. If the landlord moves it, the value could go down.

What to do: If the landlord insists on a relocation clause, read it carefully to make sure they’re advantageous to your business. They should stipulate that if the landlord’s suggested new space isn’t acceptable to you, and no acceptable spaces are offered, then the landlord will purchase your business at a favorable price that you negotiate before beginning the lease.

8. Sublease clauses can sometimes give landlords an unfair advantage.

In many cases, tenants sublease a portion of their space to a sublessee and receive a spread, which is the difference between what the tenant is paying the landlord and what the sublessee is paying the tenant. If the sublease clause allows the landlord to receive more than 50%, there’s very little incentive for the tenant to sublease, considering the possible impact and inconvenience of having a sublessee.

What to do: Negotiate a sublease clause that allows the landlord no more than 50% of the spread, whereas you keep the remaining 50%. If subleasing is an important factor in your company’s financial model, negotiate the best terms possible with the landlord. 

A commercial lease agreement is a major component of owning and operating a successful business. Negotiate all terms whenever possible. Don’t take any unnecessary risks. If at all possible, consider reviewing it with an attorney experienced in commercial real estate law.

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Steve Zimmerman, Founder, Principal Broker and CEO of Restaurant Realty Company
Steve Zimmerman (CBI, M&AMI, CBB, FIBBA) is the Founder, Principal Broker and Chief Executive Officer of Restaurant Realty Company. Steve has personally sold/leased over 1,000 restaurant, bar or club businesses, sold many commercial buildings and completed over 3,000 restaurant valuations since 1996. His real estate experience also includes sales, acquisitions, management and ownership of numerous properties throughout California including restaurants, hotels, apartment buildings, single family houses, an office building and a multi-use retail building.

Steve is also the author of Restaurant Dealmaker – An Insider’s Trade Secrets for Buying a Restaurant, Bar or Club available on Amazon. Prior to starting Restaurant Realty Company, Steve had over 20 years of restaurant experience and was President and CEO of Zim’s Restaurants, which was one of the largest privately owned restaurant chains in the San Francisco Bay Area.