Commercial Lease Overview
Understanding commercial leases is essential for any business seeking to establish, relocate, or expand its physical footprint in Arizona. Commercial leases govern the agreement between landlords and business owners or managers regarding the use of commercial space, such as offices, retail stores, restaurants, or industrial facilities. They outline rights and requirements for both parties, covering aspects such as rental amounts, lease duration, maintenance responsibilities, and regulations on how the space can be used.
Crystal clear from the outset, a commercial lease should include the following:
• Leased Premises: The commercial property being rented, including the address, square footage, and any areas reserved for landlord access (such as basements, roofing spaces, or maintenance closets) .
• Lease Duration: The length of time for which the tenant has the right to use the property, whether a fixed term (e.g., one year) or "month-to-month."
• Provisions for Default: Procedures that are to be followed in the event of a default by either party.
• Modification Procedures: How the lease may be amended, in general and in particular.
• Terms and Renewals: Rules and conditions for extensions, adjustments, and modifications to rental, among other provisions.
These provisions help ensure that the agreement between landlord and tenant is upheld and clarify expectations and standards for both parties involved with the application of clear and concise language that will stand up in a court of law.
Arizona Lease Laws
Arizona law does not require that a commercial lease agreement be in writing or that a landlord or tenant be represented by an attorney. Thus, Arizona law gives maximum freedom of contract to the parties. Also, Arizona civil law has not been changed as much as other states’ states’ civil law. For example, even if the Arizona commercial lease does not contain an implied covenant of good faith and fair dealing, the covenant applies. Many of the provisions of the Arizona commercial lease statutes can be contracted out of.
The Arizona laws governing commercial leases attempt to balance the power between individual landlords and tenants. For example, the statute imposes a good faith obligation on the landlord and the tenant where a tenant makes a request for consent to an assignment of a leasehold interest or a sublease. (Under Arizona law, the statue requires a landlord to have no reasonable objection to an assignment or sublease of a commercial lease.) Reasonable objections may include the economic conditions of the proposed assignee or subtenant, the proposed use of the premises, the reputation of the proposed assignee or subtenant and whether the proposed assignee or subtenant is likely to comply with lease terms and conditions.
As an example of the idea of freedom of contract, the lease may or may not require the landlord to mitigate damages. (The lease may even require that the landlord not mitigate damages.) In the absence of a lease, Arizona law provides that the landlord must mitigate damages if the lease is for more than one year and the land is improved. If the landlord does not comply with the mitigation requirement, then the tenant can recover from the landlord in a separate action, the greater of: (1) one month’s rent; (2) the rent reserved for the period the premises are relet to a new tenant; or (3) the present value of the rental value of the unexpired term using the discount rate of the United States treasury bill rate or any other rate agreed to in the lease.
For example, consider the following hypothetical. XYZ LLC as tenant enters into a five-year lease with ABC LLC as landlord to lease a 15,000 square-foot industrial space. The rent is $10,000 per month. However, three months into the lease term, XYZ spots a larger space in the same industrial park and decides it wants to relocate. XYZ tries to prevail on ABC to permit it to get out of the lease by offering to pay $50,000 as a lease termination fee and ABC refuses the small fee. Prior to taking possession of the industrial space, XYZ approached a known tenant and customer of ABC, DEF, to take over XYZ’s lease. After DEF and ABC execute a written sublease agreement, ABC tells XYZ it will not consent to the assignment and will hold XYZ liable for past-due, present and future rents. Assuming XYZ had made the above offer and ABC refused the $50,000, XYZ could leave with its obligation limited to $10,000, the greater of one month’s rent and past-due, present and future rents.
What You Need to See in a Commercial Lease
When entering into a commercial lease agreement, there are various critical components you need to agree upon as you consider the nature of a permissible use of a property. These elements include:
Term of Occupancy
The term of the lease is the length of time in which you can occupy the property (which is usually conjured out of a negotiation). When you negotiate the terms, it is a good idea to establish the rent increases for every year you occupy the property. For example, if you are unable to negotiate a percentage rate increase yearly, then you may want to receive a CPI increase (or cost of living increase). This is a 3% increase based on the consumer price index, which is utilized on an annual basis. It is not uncommon for a landlord to provide a lease for 3-5 years in a prosperous economy, and 5-10 years in an economic recession.
Rent Obligation
The rent obligation is the dollar amount you are required to pay to your landlord monthly. In addition to the rent, you may also have to pay any applicable Common Area Maintenance (CAM) fees, property taxes, cost of utilities and insurance for the property. CAM fees include any maintenance costs for the interior or exterior of the property with the exception of repair for a broken HVAC system. If there is a CAM fee stipulated in your lease, you need to determine whether it is a set rate for the duration of the lease, a monthly fee, or a fee that is calculated on an annual or quarterly basis depending on the expenses for the calendar year.
Not every lease agreement will require you to pay a monthly CAM fee. Sometimes the payment of such fees is included in your monthly rent, and in some instances, the landlord may choose to cover the cost or offset it with another discount to the lease or a reduction in the selling price if the land is for sale. If the lease does not specifically require you to pay CAM fees monthly, then you should negotiate this point prior to the closing of your transaction.
Maintenance
Almost all commercial lease agreements stipulate the obligations for maintenance and who is responsible for what. For example, the landlord may be required to maintain the exterior of the property, while you, as the tenant, will be responsible for maintenance inside the property. You also need to be aware of who is responsible in the event of a hotel analogy where the plumbing pipes leak, which is a common problem and can be costly to repair. As the business owner, you want to make sure that your lease properly protects you from any damage claims or costs associated with unforeseen events such as a fire. It is imperative that you check your state laws for disclosure when applying for tenant insurance prior to signing your commercial lease, as you may have to disclose the type of business you conduct at the property in order to obtain proper tenant liability insurance.
Tips for Commercial Lease Negotiation in Arizona
As with any other contract, the terms and conditions of a commercial Arizona real estate lease are open for negotiation. Below are some helpful tips to keep in mind when dealing with other commercial lease parties in functions such as drafting or negotiating required lease provisions:
There are a number of other considerations when negotiating lease provisions, including the following:
These tips provide an adequate basis for business owners looking to enter into a commercial lease agreement in Arizona.
Common Mistakes to Avoid When Considering an Arizona Lease
It’s relatively easy to avoid the most common mistakes in commercial leases, if you know what they are. But you’ve got to know what to look for. We will try to help you find a few of the most common pitfalls.
1. Out-of-date lease form. All lease forms are not created equally. Where did your lease form come from? The form you got from your friend who owns a taco truck is not going to be suitable for a $10 MM per year corporate office tenant. Your landlord’s form lease is at least customized to fit his business. But it may not include the more recent changes in the law or may not adequately address your unique business needs. An experienced real estate attorney can help you look for gaps and add protections you may need.
2. Give some thought to how the lease term is structured. Will there be rent increases in the middle or at the end of the lease term? Consider the timing of these bumps and what you think your business activity will be at the time.
If you are going into an expensive buildout, favor the shorter term – you don’t want to pay for that expense just to get out of a lease. If you have less risk of losing your deposit because you have strong credit, then favor the longer term.
- CAM and Overage . It is very difficult to manage the bottom line of your business if you don’t fully understand your expenses. This includes understanding all charges you will be responsible for under a lease. Understand how the CAM and Overage charges work. What are the chances of a percentage overage bonus increasing your rent? What does the operation statement look like? Do you have a right to audit statements and obtain backup information?
- Alterations and repairs. Sometimes what look like small alterations can have a big business impact, especially if you can’t move them. If you are not permitted to make certain alterations you need, or are restricted in your ability to alter the premises for your brand, you could have difficulty growing your business. Determine how to protect your brand while giving yourself the flexibility to modify the space as needed.
- Security. Most landlords will require some type of security, but the form and method is important. Some landlords allow multiple forms of security, such as a letter of credit instead of cash. Others may require 2-3 different forms of security, such as a deposit, letters of credit, multiple personal guarantees, etc. Decide for yourself what level of risk you are willing to accept for retaining your deposit and choose your security method accordingly.
The Impact of Written Legal Advice
When it comes to commercial lease agreements, seeking professional help is always a good idea. Your commercial lease will govern the use of the premises, and will also shape your relationship with your landlord. A poorly drafted lease agreement can leave you open to significant risk, loss of value, or even bankruptcy as a result of the addition of unforeseen costs and obligations. Likewise, as a landlord, your lease is the only protection you have from an unpaid mortgage or maintenance costs. Given all the blogging, free advice on the internet, and lease review apps out there, you may think that you have all the resources necessary to do your own lease review. However, when faced with a poorly drafted Agreement, you will very quickly learn that trying to save money now that costs you far more in the long run.
Conclusion & Final Thoughts
In conclusion, understanding commercial lease agreements in Arizona is essential for businesses looking to establish themselves in a commercial space. These agreements typically require more detailed stipulations than a residential lease, and it is crucial that business owners are aware of all the elements involved. Knowing the potential clauses included in a commercial lease can help business owners avoid any unwanted surprises down the road.
It is always suggested that a business owner works with a commercial real estate broker or a real estate attorney when negotiating a commercial lease. This can help ensure that the agreement contains standard clauses that will protect the tenant’s business. If the commercial lease agreement does not include certain ideas, like an option to renew, it is usually possible for the tenant to negotiate for these clauses. Understanding both the lessor’s and the lessee’s obligations can also be crucial to the success of your business. For example, some leases require the tenant to make any necessary repairs to the property, which may become quite costly .
Another tip for business owners is to follow some general commercial lease rules of thumbs that can often save businesses money. For example, most business owners are not responsible for building or land maintenance. Another item to take under consideration is that when dealing with commercial real estate in Arizona, there is often the ability to negotiate much of the commercial lease agreement. It can be important for a business to review the terms of the agreement to determine whether the terms are acceptable. Much of what is included in a lease is negotiable, so always speak up if changes should be addressed.
When signed, an Arizona commercial lease agreement is a legally-binding contract. If the tenant breaches any terms of the commercial lease agreement, the lessor might begin proceedings to end the agreement or seek damages incurred for a breach of the terms. To avoid a dispute, always follow the terms of the commercial lease agreement carefully. By looking out for their own best interests, businesses can find the perfect commercial lease agreement that suits their needs.