If you’re a soon-to-be veterinary practice owner, your initial reaction to finding suitable commercial space likely is excitement about the opportunity to move in and start growing your business. But before you do anything, you’ll want to focus on the lease agreement and all its implications. As with many legal agreements, a poorly drafted lease can lead to litigation. Commercial tenants are presumed to be sophisticated parties, so claims of ignorance do not fly. On the other hand, some courts assign blame for ambiguity in the lease language to the party that drafted the document — usually the landlord. With that in mind, let’s dive into the issues worth considering and the actions worth taking.
Know the Landlord
As a prospective tenant, you should learn what you can about the landlord and the building’s owner. One way to start is with a public records search. Is the landlord the same person or entity as the building’s owner, or is a third-party agent involved? Sometimes, the direct landlord is a third-party property management company and not the building’s owner. Dealing with a property management company has benefits and downsides, but your preliminary goal should be to understand your long-term business partner.
Here’s an example of how everything can go wrong when you don’t know the facts: In some states, if a landlord fails to pay the building owner or bank, the tenant can be evicted in the event of a foreclosure, even if the tenant paid the rent on time. However, tenants can avoid this pitfall by requesting to enter into a subordination, non-disturbance and attornment agreement (SNDA) with the bank. I’ll go into detail below.
Understand Base Rent, Operating Expenses and Real Estate Taxes
Your lease should delineate who is responsible for what. Most commercial leases come in three categories:
- Gross lease: It includes utilities and all other operating expenses.
- Net lease: It is more common, less inclusive and usually does not cover utilities.
- Modified lease: One of the above but with customized, negotiated changes.
Building insurance, property taxes and building operating expenses are unpredictable and often costly if passed on to tenants. Without a cap on operating expenses, tenants should negotiate a list of standard carve-outs and ensure their share of costs is proportionate to the occupied space. As for real estate taxes, tenants should always ask for copies of tax bills and try to secure carve-outs.
Address Maintenance and Repairs
Except in certain circumstances, such as when a tenant leases an entire building, the landlord should maintain common areas, the roof, structural elements and systems serving more than one tenant. The lease should address who is responsible if an environmental condition is discovered. Generally, the landlord should be responsible for correcting conditions that existed before the lease’s start date or were introduced later by the landlord. A typical scenario involves a tenant’s taking possession of space and then discovering that expensive repairs are needed to fix an environmental condition that was not apparent during a visual inspection.
Confirm Zoning Requirements
Before signing a lease, you or your real estate professional should research the government regulations applicable to your business. Local zoning laws, for instance, are important to any business owner. You’ll want to ensure that a veterinary practice is a permitted use of the property. A landlord might think it is, but that opinion might not align with zoning laws.
Deal with Assignments and Subleasing
What happens if you outgrow your space, want to sell the practice or need to vacate for any reason? Consider the question early, not later. Transferring a lease can be done by assigning the lease or subletting. An assignment means the entire lease is transferred to a new tenant. Subletting is when the current tenant keeps its name on the lease, receives rent payments from a new tenant and pays the landlord. In either instance, commercial tenants almost always need the landlord’s written consent.
Make Sense of an SNDA
A subordination, non-disturbance and attornment agreement is a critical instrument that protects the tenant by prohibiting the lender from terminating the lease if the landlord’s mortgage is foreclosed upon. An SNDA provides for:
- Subordination of the tenant’s lease to the landlord’s mortgage.
- The mortgage lender’s promise not to disturb the tenancy if the lender forecloses on the mortgage.
- The tenant’s promise to make all rent payments to the mortgage lender if the landlord defaults.
Tenants have several options:
- Agree on the SNDA during the lease negotiations and sign the SNDA and lease at the same time.
- Link the lease’s commencement date to the receipt of a signed SNDA from the lender.
- Require the landlord to use all best efforts to obtain an SNDA within “X” number of days from the lease’s start date.
Secure Indemnification
Your lease agreement should contain a covenant, or promise, by the landlord to indemnify you against any liability resulting from:
- Injuries or damage caused by negligent or willful acts of the landlord.
- The presence of hazardous materials on the premises as a result of the landlord’s actions.
- A default by the landlord under the lease.
Recognize the Right of First Refusal and the Option to Purchase
A right of first refusal is a lease clause requiring the landlord to notify you if the property is under consideration for sale so that you can decide whether to purchase it. The clause often contains a mechanism for evaluating the purchase price. An option to purchase can be a negotiated clause whereby the parties agree the tenant has the right to buy the property during a specified period if certain conditions are met. The parties typically agree on the price and the amount of rent, if any, credited toward the purchase.
Negotiate a Not-to-Compete Covenant
You want the lease to contain an exclusive-use provision or a not-to-compete covenant. Otherwise, a competing veterinary practice could rent space within the building or retail center.
Conduct Due Diligence
While negotiating favorable terms is of utmost importance, commercial tenants should undertake legal due diligence before they sign the lease. Your due diligence might include ordering a title search and requesting flood-zone certification from a title insurance company. Doing this will ensure that you uncover any liens or encumbrances affecting the property.
You also want to know whether the property has any environmental issues so that you can negotiate appropriate indemnifications.
As you consider the lease agreement, keep in mind that the advice above is in no way exhaustive. You might encounter many other issues. The key takeaway is that almost everything can be negotiated if you:
- Understand the protections you need.
- Do your due diligence on the property.
- Work with an experienced transactional attorney or broker.
- Make sure you understand all the terms in the contract before you sign it.
DID YOU KNOW?
According to the Idiom Origins website, the word “landlord” dates to the 1400s, “when it meant someone who owned so much land that some of it was rented out to tenants.”