Canada: Top 5 Tenant Issues In A Commercial Lease

Last Updated: March 20 2019
Article by Melisssa Nowak

The Greater Toronto Area leads the country with the lowest office vacancy rate of any major metropolitan area in North America (4.2% as of Q4 2018), and a stunning 1.4% office vacancy rate in Toronto's central business district1.  This may seem like an impenetrable landlord's market for tenants looking for space in the GTA, but, a savvy tenant can still negotiate some key elements into their office lease to reign in rental costs and exert control over rental cost increases.  Tenants should focus negotiating leverage on these five issues.

  1. Base Rent and Additional Rent.  The marketplace drives base rental rates and a good leasing broker can arm a tenant with optimum comparable data to negotiate the best base rent.  Once base rent is set, often at the letter of intent stage, the focus should shift to additional rent.  Here, the tenant can negotiate mechanisms into the lease to ensure the landlord is not recovering extra operating costs than what is permissible under the lease.  A great mechanism to monitor such charges is an audit right on year-end tenant reconciliations.  Upon receipt of the year-end reconciliations, where the landlord provides a high-level summary of the actual costs incurred for the previous year versus what the tenant has paid based upon a monthly estimate, the tenant should have a right to audit such costs by requesting back-up support for each line item.  However, a tenant who does not occupy a significant portion of the leasable area in the building, may have a difficult time negotiating an audit right.  There is still something a smaller tenant can do – negotiate a cap on how much additional rent can grow year over year.  This will provide certainty on additional rent costs.  And even if the tenant does not have an explicit audit right in the lease, it should still ask for back-up upon receipt of year-end reconciliations.
  2. Free Rent and Tenant Improvement Allowance.  When a tenant is in the market for space, ensure the leasing broker determines what the landlord is offering other tenants in the building as a tenant inducement, as well as inducement packages for tenants in comparable buildings within the sub-market.  Free rent and money toward building out the tenant's space are real dollars saved by the tenant.  As such, tenants should exert as much negotiating leverage on tenant inducements as they do on base rent
  3. Space Measurement.  Real estate is priced on a dollar per square foot basis.  As such, a building measurement and measurement standard become extremely important to a landlord who may be considering selling the building.  If a landlord elects to conduct certified measurement of the building, they will seek a landlord-friendly BOMA (The Building Owners and Managers Association) measurement standard and deploy a measurement consultant to measure the building.  A standard form of landlord lease will often state that the landlord, at its election, may have the space measured and rent shall be adjusted accordingly.  If, upon measurement, a tenant's office space increases from the estimate in the lease, the tenant can be sure the certified area certificate will be issued and rent will be increased.  To mitigate this, a tenant should impose a cap on how much rent can be adjusted on an upward basis in the event the certified area is greater than the estimate as this impacts both base rent and additional rent charges. 
  4. Restoration Clause. You've negotiated the best deal available for base rent, imposed an additional rent oversight mechanism, capped an increase in rent in the event of measurement and negotiated the best tenant inducement package available.  You're feeling protected, and you should, great job!  There is one costly risk to consider however, and that is whether you will incur costs upon the expiration of your lease in returning the space to the landlord.  To the extent possible, return the leased premises to the landlord upon expiration with fixtures and improvements in place, with an option, but no obligation to remove them and repair such removal.  If you plan to install tenant fixtures and leasehold improvements into your space that you do not anticipate taking with you upon expiry, ensure your lease states that you can leave items behind.  Otherwise, removal and repair of such items can be very costly.
  5. Assignment Clauses.  Imagine that your business is thriving, and you are ready to consider selling, to capitalize on all of the value you've built.  An ideal suitor puts forth an offer on terms that thrill you.  The suitor wants to acquire your entire business, including your leasehold interest.  The deal is signed, and the financial fruits of your hard work are within your sights.  But wait, your lease requires landlord's consent for assignment, in its sole and absolute discretion.   This could delay the closing of your sale and infuses some uncertainty.  Don't let this happen to you.  Negotiate the ability to sell your business and assign the lease in such circumstance without landlord's consent, or if landlord insists upon consent, ensure it must provide it if the assignee offers the same financial covenant that your company presents.    

These five focus issues are by no means an exhaustive list of how to best protect a tenant's interests in a commercial lease. However, if a tenant focuses its attention and negotiating leverage on these primary issues, they will provide some certainty and control over the leasing costs a tenant can anticipate throughout the term of their lease.

Footnote

1 https://renx.ca/office-occupancy-growing-canadas-top-markets/

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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