August 15, 2019
At Transwestern, we have seen our fair share of industrial property leasing. This includes navigating the letters of intent (LOI) on behalf of clients. The LOI is intended to form the main business terms of the potential agreement and is typically not legally binding. The LOI sets the foundation for the deal negotiation and, when done well, helps the legal contracts flow smoothly.
Here are some common questions to ask before executing an LOI:
What is included in the “base building”?
One of the most important pieces of the commercial real estate puzzle is determining the landlord’s investment in the space. Often, properties are in “shell condition,” which means the space lacks restrooms, HVAC, adequate lighting, or other basic improvements required to occupy space. In other cases, the space is outdated and requires basic upgrades to bring it to an acceptable and marketable level.
In most lease agreements, the landlord will provide a certain amount of money for the tenant to make those improvements. However, both parties need to agree on what is considered the “base building” before that tenant improvement allowance will come into effect. In other words, what exactly is the tenant starting with? It’s extremely important to delineate between what the landlord will provide as the base building and when those tenant improvement dollars will kick in. This will ultimately make the allowance go further to achieving the desired build out.
Do you have special needs for the space?
Landlords often negotiate for restoration clauses, since many industrial real estate users need special improvements such as clean rooms, labs, bridge cranes, or power drops. For these types of upgrades, it’s important to address restoration of the space prior to going to lease. Restoring a space can be a costly endeavor and certainly should be included in a leasing budget as early as possible.
Who covers HVAC maintenance and repair?
One of the worst surprises for a tenant is the failure of an HVAC unit. Not only can this provide discomfort to employees, but it can be a substantial unexpected cost. Depending on the unit tonnage, tenants could be on the hook for $5,000 to $20,000 to replace a unit. In typical industrial leases, the repair, maintenance and replacement of HVAC units are solely a tenant expense. Negotiating for the right language for sharing this cost with the landlord or perhaps amortizing the cost over the useful life of the unit can dramatically reduce this risk.
Is the lease flexible to your growth and business needs?
Flexibility is important to most organizations, especially when it comes to commercial real estate. It’s challenging to commit to a certain sized space and feel confident that it can accommodate growth or contractions. The right to assigning or sublease space is not always inherent. All tenants should negotiate for the right to assign and sublease space in the event their real estate needs change during the lease term.
What expansion options are available, and which is best for your business?
Tenants have an opportunity to negotiate for the first shot to occupy space that becomes available during their lease term. The two options are called right of first offer and right of first refusal. They are sometimes thought of as synonyms, but they are slightly different. A right of first offer is the right to lease a space whenever that space becomes available. It’s usually a one-time right for the tenant to make an offer on the available space. If an agreement is not reached, the offer typically expires after a short period, about 14 to 30 days. Realistically, this option doesn’t provide much flexibility or security to the tenant.
The right of first refusal has two parts. It first requires the landlord to have a legitimate offer in hand to lease the space to another party. Additionally, the landlord must present the same terms to the tenant with right of first refusal as an option to match those terms. Ultimately, this route provides the most leverage to the tenant when it comes to rights to expand within a building.
Is the language legally binding?
The answer is generally “no” in most cases. However, there are some common terms that landlords push for that do have some legal recourse. Terms such as the confidentiality of the proposal or the exclusivity of the negotiations are common terms that often have the legally binding language attached.
Binding or non-binding aside, an LOI should still be treated as an important document. It sets the tone and, more importantly, the expectations of the parties involved.
Do you need someone to help navigate an effective LOI?
The industrial real estate market is unique, and users benefit from the specialized knowledge in construction and leasing offered by commercial real estate companies. There is clearly a great deal of negotiating involved in every lease, highlighting the importance of tenants having an experienced occupier services broker to advocate for their interests. But their expertise doesn’t end there. True real estate advisers go far beyond the transaction to help reduce overhead costs, mitigate real estate risk, drive space efficiencies and ensure that real estate is a positive driver for the bottom line.
Nate Erickson is a senior associate in the Brokerage Services group at Transwestern. He has served the Minneapolis/St. Paul market since 2011 and specializes in representing companies in the manufacturing, distribution and life sciences fields.
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