OFFICE TERMS

Lease Term

Generally, a lease can be of any length. Five to ten years is most common. Three years is common for small transactions, especially when the tenant requires minimal renovation. Large transactions can be for 15 years or more, especially when a tenant requires substantial fit-out (build-out). Tenants with long-term leases often protect themselves with expansion, extension, and even contraction rights in the lease documentation.

Renewals

An option to extend or renew may be negotiable. A renewal option usually provides for a revised base rent, such as 95% of fair market rent. Most leases specify how to resolve disagreements as to market rents.

Escalation

Also called bumps or rent escalations. Parties often agree to a base rent increase annually or at specified future dates.

OCCUPANCY COSTS

Gross Rent

The tenant normally pays rent on a gross basis (pays gross rent). Gross rent includes a tenant’s proportionate share of base year operating costs (common area utilities and cleaning, management fees, etc.), real estate taxes and property insurance. The tenant pays its proportionate share of any increases in operating costs and real estate taxes each year. Gross rent in many US cities includes tenant's electricity, and is then called full service gross ("FSG") rent.

When a tenant pays gross rent, the landlord pays the base year operating costs of the building. The tenant pays its proportionate share of increases in operating costs for subsequent years, sometimes with a negotiated maximum, or cap. Common methods that landlords use to recoup operating cost increases are:

Direct Operating:

The tenant pays a proportionate share of operating cost increases. Operating costs are normally defined in the lease, and normally exclude the cost of amortized capital improvements and building management salaries. The landlord normally estimates the operating costs for the ensuing year and averages such costs over a twelve-month period. At the end of each year, the landlord provides an accounting of the actual costs. The landlord credits the tenant for any overages, or invoices the tenant for any underpayments. Tenants with leases that provide for direct operating increases should obtain the right to audit the landlord’s financial records.

Consumer Price Index (CPI):

The tenant’s rent adjusts for inflation based on a consumer price index, typically a local index published by the U.S. Department of Labor, Bureau of Labor Statistics.

Fixed Increases: In some cases, the landlord pays all operating cost increases, and the tenant pays a fixed percentage increase in base rent, typically 2–3.5% per year.

Net Rent

Occasionally, the tenant pays rent on a net basis, also known as triple net rent. Net rent excludes operating costs, real estate taxes, and property insurance. The landlord bills these costs to the tenant in addition to the net rent. Occupiers of single tenant office buildings normally pay rent on a net basis.

When a tenant pays net rent, then the tenant pays its pro-rata share of the full operating costs.

Rent Free

Landlords in many markets give free rent as an incentive. Free rent can be given at the start of the lease or spread over the lease term.

Management Fee

Payable monthly in advance and based on the leased area. Management charges generally include air conditioning, building security, lift maintenance and common area cleaning (Subject to revision by management company). The fee is quoted on per square foot per month and is non-negotiable and may be revised from time to time. A typical service charge for a Grade A building is HKD 6–15 per square foot per month.

Security Deposit and Guarantees

The tenant normally provides security either as a cash deposit or letter of credit. Tenants often negotiate with the landlord to keep the cash deposit in an escrow account.

Interest on the cash security deposit may accrue to the landlord or to the tenant, as negotiated. Typically, interest does not accrue to the tenant in small leases.

The amount of the security is negotiable, and depends upon the landlord’s assessment of tenant’s creditworthiness, the amount of the landlord’s outlay for tenant improvements, free rent, commissions, local market practices, etc. A strong creditworthy tenant may pay 0–2 months’ rent as security. A startup company may pay 6–12 months’ rent or more. Parties often agree to a burn-down, which is a reduction over time of the amount of security the landlord holds, if the tenant fulfils certain obligations of its lease.

Taxes

Gross Rent:

The landlord pays base year real estate taxes (property taxes), and the tenant pays its proportionate share of tax increases in subsequent years. The base year is normally the fiscal or calendar year closest to the first year of the lease term or the initial twelve months of the lease term. In most cases, the landlord provides an estimate of the real estate taxes for the ensuing year and averages such costs over a 12-month period. At the end of each year, the landlord provides an accounting of the actual costs and either credits the tenant for any overages or invoices the tenant for any underpayments.

Net Rent:

The tenant pays its full pro-rata share of the real estate taxes. Neither value added tax (VAT) nor Goods and Services Tax (GST) applies in the US.

Utilities

The tenant generally pays for electricity used in the premises, in one of the following ways:

Direct Meter:

The tenant pays the utility company directly, based on an electric meter.

Submeter:

The landlord buys electricity from the utility company and installs a meter to measure the tenant’s usage. The tenant pays the landlord based on the meter, sometimes with a negotiable mark-up for the landlord.

Per Square Foot Leased:

The tenant pays dollar amount per rentable square foot, in addition to the base rent. The charge for electricity is sometimes called the electric rental inclusion factor (ERIF), which may be negotiable and may be subject to inspection of usage by an electrical engineer. The ERIF may be subject to future increases if electric rates charged to the landlord increases or the tenant’s usage increases. Charges for above-standard electricity use, such as for data center space or for after hours HVAC use, may be billed separately. In 2012, a typical ERIF for normal office use ranged from USD 2.75–3.50 per square foot.

Included in the Rent: Electricity is included when the tenant pays rent on a "full service gross" basis.

LEASE MECHANISMS

Option to Renew

An option to extend or renew may be negotiable. A renewal option usually provides for a revised base rent, such as 95% of fair market rent. Most leases specify how to resolve disagreements as to market rents.

Option to Expand & Right of First Refusal

An option to expand or a right of first refusal may be negotiable, especially for large tenants. A right of first refusal gives the tenant the right to secure additional space that may come available during the term of the lease before it is offered to a third party.

Right to Sublet

Subletting (subleasing) is the most common way for a tenant to dispose of unneeded space. Sublets have advantages and disadvantages when compared with direct leases

Conditions:

The master lease provides for conditions under which a tenant may sublet. Typically, the landlord agrees not to unreasonably withhold or delay consent and allows the tenant to choose its own broker to act as the sublease agent. The landlord usually retains the right to approve a subtenant, especially if the proposed subtenant is a company unrelated to the tenant. The lease may limit the number of subtenants that can occupy the space. The lease may exclude some or all of the following: specific types of businesses, existing tenants, and tenants that recently negotiated with the landlord directly. The landlord and the tenant negotiate as to which party will keep any profits over and above the original rental rate. The landlord and the tenant often agree to share any such profits based on an agreed formula, often on a 50–50 basis. Profits are normally calculated typically net of subleasing costs. Profits are rare except in strong markets.

Advantages:

Rent is generally lower than rent for direct space offered by the landlord. Sublets can often include furniture, telephone systems, and cabling at no extra cost.

Disadvantages:

Most sublets have fixed terms, i.e., the remaining term of the current tenant’s lease. However, some sublessors offer flexibility in the term, especially if they sublet a portion of the space they occupy, with the intention of occupying the sublet space in the future. Subleases are riskier than direct leases because the sublandlord (also called overtenant or sublessor) may default on rent payments, possibly giving the landlord the power to terminate the original lease and cancel the sublease. The master lease, i.e., the lease between the landlord and tenant, often allows the landlord to recapture the space prior to approving the sublease.

Termination or Break

The tenant has a right (option) to terminate (break) a lease only if stipulated in the lease. Termination options usually provide that if the tenant exercises its option to terminate, the tenant will reimburse the landlord unamortized costs, including fit-out, incentives, and fees, and sometimes pay additional financial penalties.

Reinstatement Provisions

Restoration of the premises is negotiable, and may be limited to specific items such as tenant-installed internal stairways or to non-standard build-out.

Signage and Naming of Building

Exterior signage may be negotiable. Naming the building may be negotiable, especially for large long-term tenants.

Laws & Practices

Laws

Except in Washington, DC, laws that affect leases generally provide limited protection to commercial tenants; therefore, tenants' rights must be addressed in the lease document. Incentives are negotiable. They may include free rent, tenant improvement (fit-out) allowance, moving allowance, assumption of tenant's rent obligation in its prior lease, allowance for furniture, fixtures, etc. A large tenant may negotiate for signage rights or the right to name a building.

Practices

Brokers and Agents:

Tenants typically engage a tenant representative broker to represent their interests in site selection and negotiations of a new real estate transaction and for most renewals. Landlords use in-house employees or outside brokerage firms to market their space and represent them in negotiations.

Dual Agency:

In some markets, large brokerage firms, like CBRE, may represent both the tenant and the landlord in a transaction, with different individual brokers or brokerage teams representing each party, and with proper disclosure. State real estate codes and laws usually stipulate the appropriate disclosure requirements.