In commercial real estate, buyers and sellers alike are often very eager to sign a contract and get the deal underway. However, this eagerness to close shouldn’t eclipse the need to properly review the terms of the sale.
Before signing any contract, performing proper due diligence is critical so that both parties understand their obligations and agree that the arrangement is fair. That’s why we asked 14 Forbes Real Estate Council members to share some red flags people should be wary of before signing a lease for a commercial real estate property. Their responses are below.
1. Overly Optimistic Business Projections
I think the biggest red flag for a company signing a commercial lease today would be improper or too optimistic of an analysis of that business’s survivability. This is especially true if it could be negatively impacted economically once the government tapers and shuts down further stimulus support. – Rod Khleif, Lifetime Cash Flow Academy
2. Inability To Give Back Space
Make sure you have a right to give back space in the first five years. At the same time, you should also have the right to offer first for adjacent space if it becomes available. – Didhiti Bhoumik, BLG
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3. Unclear Landlord/Tenant Responsibilities
Delineations of landlord and tenant responsibilities, defined by the terms of the lease, are rightfully coming under an increasingly large microscope. It is critical that adherence to health and safety guidelines and assignments of obligation are clearly defined in the lease. Failure to include this language widens the umbrella of legal exposure for both parties. – Kevin Maggiacomo, SVN International Corp.
4. One-Sided Provisions
As with any contract, a huge red flag is one-sided provisions. Keep an eye out for things that only benefit one side and aren’t mutual. That’s a sign that a lease was probably written with many problematic provisions. Always have an experienced real estate attorney review any lease before signing to understand liability. – Jeremy Brandt, WeBuyHouses.com
5. Unfavorable Force Majeure Clauses
Landlords and tenants must pay closer attention to force majeure clauses in commercial leases. Force majeure relieves a party of its performance obligations when certain circumstances arise beyond their control. Certain tenants have attempted to use this clause to exit leases in 2020, which has led to the creation of Covid-19 carve-outs. If they’re in your lease, make sure you can live with them. – Ian Formigle, CrowdStreet
6. No Demographic Or Analytical Study Results
Due diligence is very important. Tenants who are new to the commercial market skip this phase and when they arrive at the signing of the contract stage, they believe everything has been resolved. They do not examine the demographic and analytical study results, leading them to discover that they will not get the revenue they expected. Once that happens, it’s too late and they are already bound by the contract. – Rodrigo Brandao Schiavo, Premier Capital Realty, LLC
7. Verbal Confirmations
Commercial real estate should be treated like a business and you should never trust someone to keep their word. Everything must be in writing. If any property owner wants you to take their verbal confirmation, you shouldn’t work with them. – Raja Seetharaman, Propstack
8. Pass-Through Language About Planned Capital Projects
Tenants should request a three-year operating expense history on the property and a list of any capital projects planned for the next year or two. Then, negotiate the pass-through language carefully in the lease. Landlords will attempt to recover as much of their costs as possible over the term of the lease. – Nathan Anderson, NAI Heartland
9. Vague Math Calculations
After the tenant and landlord are named in a lease, everything else is a flag. Be clear in all terms including the math. If there are rental abatements, early termination clauses and fees or rent escalations, make those numbers part of the document. Net terms and core factor definitions are paramount, but agree on the math upfront. Write it out for 10 years and one headache is averted. – Kristin Geenty, The Geenty Group, Realtors
10. Lack Of Landlord Obligations
A lease should include a listing of various landlord obligations. These obligations are typically defined within the term sheet during early negotiations. The term sheet will identify shortcomings of the building and/or required modifications, such as upgrades to restrooms, lobby areas and corridors, MEP Systems, demising walls, lighting, etc. Additionally, it will describe operational needs and amenity incentives. – Peter Ferzan, Ferzan Company LLC
11. Unclear Intended Uses
I believe that any tenant should make sure that they can operate as planned in the space they have chosen. This includes your current operating needs and any future plans the space will have to accommodate. Check with the governing zoning body in the area of the property. Ensure you are open about your current operation and future plans as they relate to space. – Michael J. Polk, Polk Properties / Matrix Properties
12. Sloppy Documents
A document that’s sloppy or error-ridden is a very bad sign. Everything should be correct and complete, including the identity of the owner. Ensure the property is in the agreed-upon condition so that you’re not liable. Make sure that the rent, who pays what expenses (such as maintenance), the number of people allowed to live at the property, etc. is lease assignable and spelled out. If the answer to any questions is, “I don’t know,” run away! – Charles Argianas, Argianas & Associates, Inc.
13. Poorly Written CAM Definition
How does the fine print read with regard to the CAM definition? What is included or not included? Poorly written and vague descriptions can cause confusion and conflict if an issue arises. Extremely lengthy definitions may include things that are uncommon like all major capital improvements. Is there a cap on the per annum increase? A major jump could affect a business owner’s budget significantly. – Catherine Kuo, Elite Homes | Christie’s International Real Estate
14. Failure Of Either Side To Hire An Attorney
One common red flag is not hiring a proper attorney to review the lease for you! You should always have a local attorney to assist with reviewing and signing any new lease or sale. – Heidi Burkhart, Dane Real Estate