Going Commercial – What You Need to Know Before You Sign That Studio Lease

*Warning!  Long post – you might want to just read the last paragraph and move on!  

After years of operating your photography business out of your dining room, you have decided to take the plunge and open a studio in a commercial building. You are excited to finally have a place where you can meet with clients, create sets that you don’t have to tear down before you serve your family dinner. To top it off, you have found a great space in a commercial building downtown where the rent is affordable. Yes, the building has been empty for quite a while and your space is around the back where visibility from the road is poor but the rent is lower than anything else in town. Also, you plan to cross market your senior portrait clients and bridal boudoir clients with the salon that is the same building and occupying space next to a salon is a must for you. Further, the high school kids walk right past this building on their way to the ice cream shop after school every day and there is no other photography studio in the area. The space needs some work – you want to put in wood floors, install some faux brickwork and your new motorized backdrop system and lighting equipment that you have purchased just for the space.  You plan to spend quite a bit of your own money on equipment and furniture but if you can stay in the space for at least 4 years you will have all of that paid off and be turning a nice profit.  The landlord has agreed to a two-year lease but says that he sees no reason why you wouldn’t be able to renew for longer if everything goes well. You cannot wait to get started and you just met with the landlord, signed the form lease and obtained your keys. You are very excited! What could go wrong?

A Look at the Lease:

1.         Rent.  So, the rent in your new space is lower than anywhere else in town and you are congratulating yourself on a bargain found. But, be careful that your lease doesn’t contain surprises. Sometimes in cases where a building is empty, landlords entice tenants with the promise of low rent. But lurking in the lease is a provision that states that as soon as the building becomes more occupied, your rent is subject to increase. If you negotiated a fixed rent deal for the term of your lease, make sure that the lease states that the rent shall not be increased and check for any language that states otherwise. Even if that is not an issue for you, make sure the lease states what you actually negotiated. Many leases provide a fixed rent for the first year but rent is subject to increases each year thereafter. Sometimes the increases are fixed by a certain percentage or a flat amount. Other times the increases are tied to a Consumer Price Index (CPI) – like inflation. Increases like that are not within your control and you could end up with a much higher rent than your budget allows.  If the landlord insists on such increases, you can try to negotiate a cap for some protection. While it may not always be possible to negotiate a flat rent, be sure you understand how any increases are calculated.

Another form of rent that you may see in a lease, especially if you are in a commercial shopping center, is “percentage rent.” This is rent that is based on a percentage of your gross sales. While this would not be typical for a photography studio, it’s best to be aware of it in case you do run across it.  Sometimes landlords will allow you to pay a lower fixed rent in exchange for an agreement by you to pay additional percentage rent. Basically, it’s their way of saying “hey, I think you will do well at my center so I’ll give you a lower rent to get started but if you do well, you pay me extra.”  These provisions can sometimes be based on a floor whereby it only kicks in if you gross more than a certain amount of sales in a year. Percentage rent provisions are cumbersome and require careful accounting and reporting to a landlord and the landlord has the right to audit your books and records.  You also want to be careful to strictly define what constitutes “gross sales” and what is exempted.

2.         Term. The term of your lease is how long your lease lasts.  It is the period of within which you will have to pay rent and fulfill all of your lease obligations even if you aren’t occupying the space. So, you need to decide how long you want to be there and how long you can afford to be committed to lease obligations. If you are already an established business in the area and you know you don’t plan to move, it may not be too risky for you to sign a lease with a term of 5 years or more. If, however, you are just starting out, you may want to stick to a shorter term. If you are going to be investing money in a space, you certainly want to be sure that you have the right to stay long enough to make the improvement costs worth the investment. You may want to consider negotiating the safer, shorter term but also negotiate options to renew so that you can elect to stay in the space if everything is going well but you don’t have to stay if things are not.  The lease should set forth the rent for your option periods so that you know what you will be paying if you exercise your option. Don’t rely on the landlord’s word that you’ll be able to stay. Without a valid lease with enforceable options to extend, the landlord has no obligation to allow you to stay and could demand much higher rent knowing that it would be difficult for you to make a move.

3.         Pass Through Charges (Taxes/Insurance/CAM) – Many commercial leases are “triple net” leases which means that, in addition to rent, the Tenant is responsible for paying to the Landlord some amount for taxes, insurance and common area maintenance (CAM) costs attributable to the property. Negotiation of these items can get tricky and confusing. Many leases in shopping centers, for example, will require a tenant to pay its share of these expenses. Seems fair enough, right?  But, what if, as in the hypothetical above, the tenant is renting only a small space in a large building that is mostly empty?  A tenant would need to be sure the lease language regarding these charges is drafted in such a manner so that the tenant isn’t stuck paying all of these expenses for the entire building. If you are looking at a triple net lease, try to get the Landlord to fix these costs for you in the lease. At a minimum, state the estimated costs and be sure the formula for calculating your share of these expenses is based on a pro rata share using the square footage of your space as compared to the TOTAL square footage of space in the building. This way, you can be sure you are paying only the amount allocable to your space. Be sure you ask the Landlord to outline any and all pass through charges and exactly how they are calculated. If you can get them to a flat rate throughout the entire term, even better.

4.         Signage/Visibility/Parking – Of course you want your clients to be able to find you and visibility is key for marketing and making sure people know about you. But the space you have rented is in the back of an empty building. How are people going to know you are there?  Your sign of course!  Make sure before you sign the lease that you know what your rights are with respect to installing signage both on the front of your space and on any signage by the road or in the parking areas to direct people to your space. Many commercial buildings have restrictions on size, color and materials used so make sure that you have the right to install what you need and that you can afford to comply with the building’s standards. Signage can be very expensive so don’t set yourself up for surprises. I typically advise my clients to submit their sign plans to the landlord prior to the lease signing and get approval stated in the lease. Also, be sure that you have all permits and approval from local government as some areas can be quite strict and design committee approval may be required.

Related issues to think about when renting a space that is off the beaten path are lighting, parking and access to your space. If your space is in a dark corner of a building, make sure the landlord is required to maintain sufficient lighting in the parking and common areas so that your clients have a safe, well-lit path to your door. It is also advisable to negotiate a specific parking area for you and your clients that is close to your space. Many centers have strict parking requirements and the landlord can fine you if you do not comply. Make sure you check your lease for any restrictions on parking.

 5.         Maintenance/Repairs/Renovations. These provisions are very important, especially if you plan to install new equipment and make any changes to your space. First, with respect to renovations and improvements, you will want to be sure that your lease allows you to make improvements necessary for the operation of your business. If you know exactly what changes you want to make to the space, the best bet is to get the landlord’s approval up front and attach your plans and specifications as an exhibit to the lease. You may even be able to negotiate a tenant allowance where the landlord funds some of the improvements.  Of course, if you want the flexibility to make further changes during the term, you will need to make sure you have that right. With respect to repairs and maintenance of the space, be sure you understand exactly what you are responsible for. Many leases in commercial shopping centers make the tenant responsible for the HVAC equipment, utility lines exclusively serving the premises, plate glass and all interior walls, floor coverings, etc. In other buildings, the landlord may be responsible for those things. Be sure you understand exactly what you are responsible for and make sure that the landlord’s repair and maintenance obligations are also set forth and that you have remedies in the event the landlord fails to perform.  Imagine how surprised you would be if your air conditioner goes out in the middle of summer and you call the landlord only to learn that you will be responsible for installing new HVAC equipment in the space.

6.  Cotenancy. An interesting issue raised in the scenario above revolves around a co-tenancy situation. A co-tenancy clause is a clause that may be requested by a tenant who has an interest in making sure that another tenant or another type of tenant is located in the same center or building. While co-tenancies are usually reserved for big box tenants or national tenants, a small, local business might have some negotiating room to include such a provision. In the above-mentioned scenario, you have chosen this particular space based on the fact that a popular salon is located in the same building. But what happens if the salon leaves?  Would you still want to lease the space?  If not, you are going to want to try to negotiate a termination right or maybe a lower rent if the salon leaves or ceases operating. Co-tenancy provisions can get quite creative and need to be carefully drafted to be enforceable.

 7.     Use Clause/Tradename –  The lease you have signed says that the space may used as a photographic studio under the name “Jane Doe Photography” and for no other purpose. Well, you are a photo studio and that is your name so no problem, right?  But what happens if you need to get out of your lease and need to sublet or assign your lease?  Will you really be able to find another photo studio to take the place?  Even if so, they certainly won’t be operating under your name. Or, what if you decide you want to open a boutique in part of the space that does retail sale of baby clothes, hats and blankets? It is best to negotiate some flexibility into the use clause. I typically ask for “any lawful use” to make sure all options are open. And I always ask for the trade name requirement to be deleted. Unless you are a chain whose name draws lots of customers (such as “McDonalds”) the Landlord should not have a problem with such a request.

Another issue that can cause quite a problem in many leases involves continuous operations clauses. Landlords of shopping centers usually are concerned that the spaces are not “dark” and the tenants adhere to specific operating hours and do not shut down for long periods of time. Be sure to negotiate operating hours that fit your business, including the right to stay open in the evenings and on weekends if necessary. I always advise tenant clients to negotiate the right to close their doors if they need to. If your business isn’t doing well and you need to cut your losses, it may be necessary for you to close the business even if you can’t terminate the lease. But if you have a continuous operations clause, you could be in default if you close, even if you continue paying rent. Many landlords will agree to a recapture clause whereby they have the right to take the space back if you close your doors.  Sometimes a landlord will even allow an early termination clause that is based on how well your business does in the space. Allowances like these may come with a penalty fee.

8.         Assignment/Subletting – In connection with the paragraph above, make sure that the lease allows you to sublease or assign your lease in case you run into a problem and need to get out before the term ends. Most landlords will want some control here and will require that they provide consent first. In that case, negotiating language that requires that the consent not be unreasonably withheld will give you a little more leeway.  And you should always get some language allowing an assignment to a subsidiary or owner of your corporation or LLC in case you restructure your business.

 9.         Use Restrictions – Connected with your use clause, many commercial leases contain a long list of use restrictions. These are uses that are prohibited in the center. Most them are pretty straightforward such as “no tattoo parlors.”  Others may be more vague. Most commercial leases I have seen include restrictions on “any use that would injure the reputation of the property.”  Huh?  Well, let’s see. You have told the landlord that you are a photographer but did you disclose that about 50% of your business is boudoir photography?  “Not his business and anyway, it’s very respectable.”  Well, people in the community may not agree and the landlord may get complaints – especially since the space is so close to the high school. I typically ask for a representation from the landlord that the tenant’s specific use is approved.  For example: “the tenant’s current use as a portrait photography studio which includes but may not be limited to children’s portraits, family portraits, senior portraits, boudoir portraits, fashion and glamour portraits, and any other form of portrait photography shall not be prohibited so long as tenant complies with all laws and local ordinances.”

10.         Utilities. Most commercial leases provide that a tenant is responsible for hooking up and paying its own utilities. No problem, right?  But many leases also state that the tenant may not overload the building’s capacity for electric service. What about all those lights you plan to install?  Can the building handle constant use of strobes, hair lights, etc.?  If not, and you cause an outage, not only would you be in default of the lease but you could be responsible to other tenants for the disruption in their service. It is best to inform the Landlord up front of what you plan to install, what the required capacity is and then have the Landlord state in the lease that the premises has sufficient electric capacity to support such equipment.

11.      Insurance and Indemnification.  Most commercial landlords have strict insurance requirements and will mandate several types of insurance a tenant must have, including personal property insurance and liability insurance. Most also require that your insurance name the landlord as an additional insured. Make sure you review the requirements in your lease carefully and discuss them with your insurer so that you know whether you are going to need to spend money increasing your coverage limits, adding coverage etc. Also, be sure the lease requires the landlord to carry and All-Risk policy on the building and liability coverage. The lease should always contain a mutual waiver of subrogation so that the landlord’s insurer can’t come after you for claims covered under its policy and vice versa. Also, watch those indemnification clauses. Many landlord forms include an indemnification from the tenant only. Indemnifications should be somewhat mutual. Typically in commercial leases, a landlord will agree to indemnify you for anything that occurs outside of your leased premises so long you indemnify them for any damages occurring inside the leased premises. There are sometimes exceptions for negligence, gross negligence and willful acts and how much each side is willing to give depends on the size of the space, the financial strength of the deal and what the insurers will tolerate.  I have negotiated many variations of indemnity language and it can get quite complicated. Always have your lawyer look over these provisions to make sure you aren’t putting yourself at more risk than is necessary.

12.      Exclusives. An exclusive clause is something you may want to consider if you have any negotiating power in this deal. This is a clause that gives you the right to be the only tenant who conducts your use in the landlord’s center or building. Sometimes, these clauses can extend to other properties landlord may own within a specified radius outside of the center. So, for example, you discover that your landlord also owns three other buildings in the area and that other photographers have been looking at these spaces. You want to be sure that you are the only portrait studio in this little area so you negotiate a provision in the lease whereby the landlord agrees that, during the term of your lease, the landlord agrees that it will not lease space in the building or in any of landlord’s properties within a three-mile radius to another portrait photography studio. These clauses can get quite creative and sometimes complicated. They have also been attacked as creating a restraint on trade. If you are successful at negotiating an exclusive with the landlord, be sure an attorney reviews the language to ensure enforceability.

 13.      OEA/REA Issues. If the space you are renting is a part of a bigger overall development such as a strip mall or other commercial development, your lease will likely have language requiring that you comply with all provisions of an Operation Easement Agreement (“OEA”) or “Reciprocal Easement Agreement” (REA) or a Development Agreement or some similar document or a combination of several. Most landlords will throw in a statement in the lease that says something like “Notwithstanding any provision in this lease, the tenant agrees to comply with the REA that is recorded in land records for the county……”  Well, even if you have very carefully negotiated all of your lease provisions this could pose a problem if a provision in the REA contradicts the lease. Always ask for the landlord to give you a copy of every recorded document that you will be obligated to comply with, list them in the lease and ask the landlord to be the one to ensure you are in compliance by changing the language above to something like this:  “Landlord hereby represents and warrants that the terms of this Lease do not conflict with any REA, OEA or other agreement or document affecting the property and Tenant shall at all times be permitted to operate the Permitted Use as provided herein.”

Commercial leases contain many other provisions, including but not limited to, provisions dealing with common areas, holdover, damage and casualty, condemnation, mandatory arbitration, choice of law provisions and others. I have touched on the ones that in my experience can cause the most operational issues for photographers. Every provision in a commercial lease has a legal meaning and legal and financial consequences. Otherwise it would not be in the document. The old saying “it’s not a problem until it’s a problem” is so true when it comes to commercial leases. For example, you may completely ignore the condemnation provisions thinking “oh that’s never going to happen,” and then 13 months into your lease when your business is booming, the county decides to condemn your building to widen a road. I know, I know, I’m all doom and gloom. But I spent three years in law school and 17 years in the practice of law learning how to prepare for the worst so that I can best protect my clients.

* And here is the best advice this long article contains:  ignore everything above and hire a lawyer to handle your lease negotiations for you. Spending a little money now will save you a huge headache a lot of money later!

 

Kirsten Kowalski has practiced commercial leasing law for over 17 years.