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Inking a No-Fleece Lease

Thousands of Gulf Coast entrepreneurs with businesses destroyed by Hurricane Katrina will spend the coming months pondering whether to reopen in new locations or return to refurbished buildings back home.

Contending with commercial leases will make up a vital part of the process. John Logan, an attorney and shareholder with Minor, Brown P.C. in Denver, has specialized in commercial real-estate leases for more than 20 years. He recently offered up some tips to Smart Answers columnist Karen E. Klein. Edited excerpts of their conversation follow.

What property concerns will displaced business owners be confronting in the near future?

They'll want to think about their current property leases in the hurricane area. A lot of sophisticated commercial leases include provisions that suspend payments after a disaster, but they also say that if a damaged space can be repaired within a certain period of time -- usually six months to eight months -- the leases start right back up again.

So if a building is refurbished within that time, the displaced tenants will have a contractual obligation to make the lease payments, whether or not they have employees, vendors, infrastructure -- let alone customers.

Even worse, some poorly written leases don't suspend the rent at all, even after a hurricane or flood. Some require the tenant to continue to pay operating expenses -- and rebuild the facilities. So, many commercial tenants are going to have very serious issues to deal with in terms of who pays for what.

If the tenants have a good insurance package that covers business interruption, they would have insurance money for those expenses. But many small businesses don't carry that kind of insurance, because it's more expensive.

What about those who want to carry on business in a new location?

Tenants relocating from a hurricane area will want some flexibility and should consider a short-term lease with an early-termination option. It may be that their old space will be back up and running in a year, and if the old landlord tells them to come back and resume the existing lease, they'll need a termination provision on their new lease -- or they'll be paying double.

Along with the early termination option, what should hurricane-displaced business owners think about as they're contemplating new leases?

For many of the business owners displaced by the hurricane, their best bet will be a sublease. With the economy over the past few years, businesses have been shrinking their staffs, and they have a lot of space they're still paying for but can't use.

So there are an awful lot of subleases out there, and they can often be had for less money on a short-term basis. It's a win-win for the displaced tenant and the one with too much space.

What if an entrepreneur wants to make a fresh start in a new place where he or she intends to remain for the long-term?

My advice is to consider that the form of the lease is very important. On one end of the spectrum, there are "triple-net" leases. On the other end you have "gross" leases. And then there are in-between arrangements.

With a triple-net lease, the rent you pay to a landlord does not include taxes, insurance, repairs, or maintenance. These kinds of leases are typical for stand-alone buildings that might be leased to an industrial or manufacturing business.

With a gross lease, which would be more typical in an office or retail space, you pay one monthly amount -- and then the landlord pays for everything else.

In a modified gross lease, you pay the landlord a set sum monthly, and then you pay annually a percentage of the property's operating expenses based on how much space you occupy.

Is one type of lease more desirable than another?

From a budget standpoint, it makes more sense if a business can define what its expenses are going to be up front. With a gross lease, you know that, every month, you'll write a check for a certain amount.

With a triple-net lease, your base rate will be fixed, but your operating expenses will change from month to month as you have to pay property taxes, replace a roof, or fix an elevator. If you're only going to be somewhere two years while your location in New Orleans is rebuilt, don't agree to be responsible for that kind of black hole of uncontrollable operating expenses.

How does one avoid it?

Via a careful review of the lease and good negotiating skills. A lease may say that, if a $25,000 air-conditioning compressor goes out, the tenant should pay for it. A tenant in that situation can say, "No, but we'll pay for part of it."

If that agreement is reached, the landlord would front the bill for the new compressor, which should last 10 years. If the tenant's only going to be there two years, she or he would pay two-tenths of the cost. It's referred to as "amortizing" those major repairs or replacements.

There are a lot of details to negotiate in a lease. Do prospective tenants sometimes sign them without examining all those details?

Yes, and that's my pet peeve. You wouldn't buy a $2 million building without carefully negotiating the real-estate contract, conducting a physical inspection, and doing due diligence, yet many people sign million-dollar leases without carefully reviewing them.

It's imperative that, before signing a any lease, tenants get an expert review from a lawyer with ample leasing-negotiation experience. Commercial leases are written to cover anything and everything the landlord can think of, and they're very, very pro-landlord. It's rare, if ever, that you see a lease that is completely fair.

But you can use your bargaining power to negotiate better terms into your lease. Even if you're renting just 1,500 square feet in an office building, you'd be surprised how many things a landlord will negotiate if you ask.

Have a question about your business? Ask our small-business experts. Send us an e-mail at Smart Answers, or write to Smart Answers, BW Online, 45th Floor, 1221 Avenue of the Americas, New York, N.Y. 10020. Please include your real name and phone number in case we need more information; only your initials and city will be printed. Because of the volume of mail, we won't be able to respond to all questions personally.

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