How to lease commercial real estate
Once you’ve decided to rent a new commercial real estate space, what’s next? Whether you’re transitioning out of a home-based business or expanding into a larger space, the decision to rent can come with many risks and worries.
“Taking a little time to plan for your company’s needs when leasing can help you avoid a lot of common mistakes,” says BDC Corporate Financing Director Reese Jenkins. “Talking early with a good lawyer and your banker can help you avoid problems, such as hidden costs or tight cash flow, that often crop up.”
Jenkins offers these six steps to follow when leasing commercial real estate.
1. Review your business
First, take stock of your business to figure out your real estate needs. Plan your space needs for the next several years. If you’re growing quickly, you may want to sign a short-term lease or look for a space with expansion possibilities.
Also, consider ways to reduce your square-footage needs by improving the efficiency of your workspace. (An efficiency expert can help you with this task.) Review your financial situation, and set a budget for your lease. As well, think about the timing of a move. For example, if you’re busiest around Christmas, you should probably plan your move at some other time of the year.
2. Get advice
Discuss your needs with your team of commercial real estate advisors and partners, and get ideas. You may want to have a preliminary talk with your banker about any financing needs you’ve identified during your lease budgeting process. Find a commercial real estate broker to help you search for a space.
It’s also useful to talk to business associates, suppliers and others about their leasing experiences. Find out what worked for them and what they’d do differently.
3. Explore your options
As you start your search for a space, be flexible. Your initial expectations about locations, types of spaces and rent may have been unrealistic and could need adjusting. A good agent will help educate you about the market and your best options.
You may need to expand your search or adjust your budget. For example, a more remote location may offer better rents. You could also consider renting a larger space than you need, then subleasing part of it to help pay the rent. (If you do this, be sure your lease allows you to sublease.)
Once you’ve found a promising space, don’t just sign whatever lease the landlord offers. A lease is usually open to negotiation. Before signing, understand all your costs, including such incidentals as property tax, insurance, utilities and maintenance. Ask the landlord to provide tenant inducements—for example, a couple of months rent free or help with the cost of leasehold improvements.
You should also discuss leasehold improvements. For example, are you allowed to build an extra bathroom or install needed machinery? Clarify who will own the improvements when you move out. Unless otherwise specified in the lease, anything attached to the building usually becomes the property of the landlord—meaning you can’t take it with you when you move out.
Hire a good commercial real estate lawyer to go over the lease to make sure your business is protected and there are no surprise expenses.
5. Get financing
With a lease in hand, go back to your banker to talk about financing. Explore and understand all your financing options. Many businesses make the mistake of using their working capital to pay for leasehold improvements and moving expenses.
“Businesses tend to underestimate how much a move drains their cash,” says Jenkins. “If you have a cash shortage after your move, it could hamper your ability to ramp up production, buy inventory or hire a couple of new sales reps. That means you won’t be able to use your new space to its full efficiency.”
Financing options to help defray leasing costs can include the following.
Leasehold improvement loan
A short-term loan (usually amortized over five or six years) that can help cover the cost of renovations to prepare a leased space for your business. You may be able to negotiate a principal holiday for the first six to 12 months of the loan, which could help you absorb transition costs.
Depending on the value of the improvement, a bank may accept the improvement as collateral for the loan, which could result in a lower rate than that for an unsecured loan. Many leasehold improvements don’t have tangible value in a banker’s eyes. Bankers generally want to see that your business has a history of profits and solid cash flow, with promising cash flow forecasts.
“Bankers like their clients to have a healthy balance sheet, a strong management team and business plan, succession planning, and projections for how the new space will benefit the company,” Jenkins says.
Working capital loan
Another short-term loan (also usually amortized over five or six years), meant to help you pay for investments in growth. Working capital loans are generally unsecured. Bankers will ask you to provide the same information as for a leasehold improvement loan.
Line of credit
A short-term, flexible loan that you can tap quickly to cover temporary cash flow shortages.
6. Plan the transition
Work with your employees to plan a timetable for a smooth transition to the new space. Be sure to build in time not only for moving assets, but also for making leasehold improvements and dealing with production downtime during the move. Keep in mind that transitions often take longer than expected.
Plan and execute improvements with the help of your team and a contractor. Consider getting a few quotes for the work, especially for major renovations.