5 Most Common Red Flags Entrepreneurs Should Know Before Signing a Commercial Real Estate Lease in New York
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“If I can make it there, I'll make it anywhere. It's up to you, New York, New York.”
When Frank Sinatra first sang those words in 1978, we can surmise he was envisioning the city’s iconic skyline, not the nitty-gritty details of commercial tenant contracts. But decades later, the lyrics are true for small business owners renting space in the very buildings that make up that view.
New York is shadow-governed by some of the most powerful real estate conglomerates in the country -- Vornado Realty Trust, Blackstone Group and Brookfield Asset Management, among others. The existence of these “mega-landlords,” as well as high expenses across the board, often means the odds are stacked against commercial tenants. For one, many lenders prefer to rent to larger chains with extensive credit histories rather than small business owners. There’s also the matter of renovation costs: In New York, some commercial spaces can cost between $200,000 and $400,000 to upgrade a commercial space to be move-in ready. And then there’s average retail lease length in New York City: about 10 years, compared to half that nationwide, according to the CBRE. That’s a big commitment for an entrepreneur in a frequently topsy-turvy market.
“In New York, there is very little statutory protection [or laws ensuring certain rights] for commercial tenants,” said Kevin McConnell, attorney and partner at Himmelstein, McConnell, Gribben, Donoghue and Joseph, LLP.
What’s a small business owner in the Big Apple to do? Fortunately, there are resources available to help you come out ahead on your next lease contract. LegalZoom offers consultation calls and contract reviews with an attorney, starting at $216 total for a six-month subscription. The New York City Bar Association offers 30-minute phone consultations with attorneys that are either free or cost $35, depending on the type of case. The New York City Department of Small Business Services (SBS) offers a Commercial Lease Assistance Program for qualifying business owners, free of charge. And the tables may be turning via City Hall, as well.
“There's a proposal in the City Council -- there is a bill pending -- whereby commercial tenants do have the right to negotiate with their landlord when their lease expires and the landlord must act in good faith, but there's nothing on the books yet,” said McConnell.
Fear not: No matter which neighborhood you’ve set up shop in, Entrepreneur compiled five of the most common landlord-tenant issues you may face as a commercial renter -- plus what to know before you sign that contract.
Watch out for: A lapse in your commercial real estate lease
When meeting with a small business owner as part of the SBS Commercial Lease Assistance Program, the first question an attorney usually asks is: Do you have a lease, and can I see it? That’s according to Gregg Bishop, Commissioner of the NYC Department of SBS. In his experience, landlord-tenant issues often arise after a lease has expired and the landlord continues to accept the rent without providing new lease terms. “The lease is the most important instrument in terms of protecting you for future potential issues that you'll have with your landlord,” said Bishop. “It spells out how each party will respond.”
The SBS program recently introduced its free legal help for commercial leases, and so far, its attorneys have helped negotiate contracts -- new or renewed -- to procure fairer terms for about 400 enrollees. New York City business owners (excluding franchisees) can apply here, and after submitting the required form, an attorney should reach out within three business days.
Watch out for: The tax escalation provision
Most commercial leases have a potentially sneaky section called the tax escalation provision, which stipulates the tenant will pay a percentage of additional rent according to changes in the building’s tax rate. It’s largely determined by a “base year” laid out in the contract, said McConnell. Let’s say you rent a space for $150 a square foot, and the contract’s tax escalation provision has a base year of 2019. You might think $150 a square foot is a great deal and sign right away, but eight years into your lease, you could be paying much more per square foot because of increases in the building’s taxes -- a percentage of which you’re already locked into paying.
McConnell’s solution? Try to have the base year moved forward if possible -- say, 2020 instead of 2019 -- and ensure the percentage of the tax increase you’ve agreed to pay is proportionate to the amount of space you’re renting in the building. For example, if it’s a four-story building and you’re renting the entire ground floor, the tax escalation provision should stipulate no more than 25 percent.
Watch out for: A strict personal guarantee
If you’re the owner of a limited liability company (LLC), renting a commercial space often requires a personal guarantee. That means that even though your LLC is the named renter, you are essentially a “guarantor” for your own company, said McConnell -- in other words, you’re promising to personally take on financial responsibilities for the space if the LLC ends up falling short. If you do agree to a personal guarantee, make sure the contract includes a “good guy clause.” It’s an agreement stating that if you’re having trouble paying rent and need to vacate the premises, you can hand over the keys to the landlord with a certain amount of notice to be released from the lease.
“Most landlords will give that kind of a ‘good guy clause’ -- if they don't, then tenants shouldn't sign the lease,” said McConnell. “Most entrepreneurs… don’t see themselves failing in six months.” Something else to look out for: Make sure the amount of notice stipulated in the clause is no more than two months (or 60 days). McConnell said he’s seen leases under which the tenant has exercised the right to vacate but isn’t released from their personal guarantee until six months later.
Watch out for: Unclear terms for what happens if your building changes ownership
Received a letter in the mail -- or taped to your door -- that your building is changing ownership? It’s time to take a close look at your contract. Depending on the terms, it’s possible that the new owner could void your lease once their purchase goes through, said Bishop. There’s a potential for the new owner to take that “escape clause,” void all the leases and then offer to re-issue them with new terms (and higher monthly rents).
“You can protect yourself as an entrepreneur by ensuring that if ownership changes, the lease terms do not change,” said Bishop. Before you sign a lease, carefully read any provisions about ownership changes for the building. If there aren’t any protections for your current lease terms, alert the landlord of your concerns. After consulting an attorney, you could even propose your own addendum.
Watch out for: Commercial tenant harassment
Maybe the heat stopped working. The refrigerator broke. Water service is constantly interrupted during normal business hours. There are copious amounts of creepy crawlers afoot. Whatever the issue, standard commercial contracts usually attribute responsibility for regular repairs to the landlord, plus dictate that they be completed in a timely manner. If your landlord is making it difficult for your business to operate, there’s a chance they could be attempting to push you out of the space. That likely falls under commercial tenant harassment, said Bishop -- it’s similar to breach of contract but with financial penalties attached.
Before September 2016, tenants looking to litigate with their landlords had no recourse. But that’s changed thanks to the “Non-Residential Tenant Harassment” law, which spells out behaviors that qualify as commercial tenant harassment. Take a look at your contract and make sure that clauses on timely repairs are included. Alert your landlord that you’re aware of the contract’s requirements, and if you still don’t hear back, it may be time to consult a commercial tenant attorney. They can reach out to the landlord to let them know they’re in danger of breach of contract, plus potentially negotiate new terms for the next lease. You can have an attorney prepare a “cease and desist” letter for your landlord, and if you end up vacating the space because of unworkable conditions, that counts as a “constructive eviction,” said McConnell -- meaning that since you’ve essentially been denied use of the space, you are entitled to leave with no obligation to continue paying rent.
One more thing to note: An attorney will likely never advise you to withhold rent because doing so could strip you of your power in the situation, said Bishop. Failing to pay rent automatically puts you in violation of your lease, and the idea here is to prove the opposite -- that the landlord is the one who’s violating terms. It’s a good idea to speak with an attorney first; they can send an official notice to the landlord, including a deadline by which they must remedy the situation -- plus the actions you’ll take if they fail to deliver.