Due Diligence Essential for Businesses When Leasing Space

All too often in the commercial real estate world, we think about due diligence strictly as it applies to the purchase of commercial property or land. However, doing thorough due diligence can be just as important for a business looking to lease commercial space (whether office, retail, or industrial). A recent case that came to our office illustrates this.

The tenant was a business looking to move into an older yet upscale retail shopping center in North Scottsdale. The tenant had been unhappy in their current location and with their current landlord and its property manager for many years. They were eager to move and the space at issue was a second floor one in the shopping plaza they had been dreaming about moving to for awhile. The tenant’s business was rather specialized and would require considerable physical alteration to the leased premises. Their business would also, periodically, host a number of patrons in one or more partitioned rooms for lesson and instruction purposes. After going round and round with the landlord’s leasing agent, including exchanging a number of drafts of the commercial lease, the tenant and landlord finally arrived at a tenant improvement (TI) allowance and deferred rent period that they could each live with.

However, while the tenant had toured the space on a few occasions, it was only after the business had already signed the lease (including personal guaranties by all of the partners) and they had paid their deposit that they went in to look at the new space with their general contractor. After inspecting the newly leased premises, the tenant’s GC informed the business that the space was likely not compliant with City code or the American Disabilities Act. Worse still, because certain parts of the proposed space were going to accommodate large numbers of customers in enclosed areas, the City would likely require fire doors or escapes be added through to the exterior! Now, what had seemed initially like a generous TI allowance beforehand was now quickly evaporating before the tenant’s eyes when budgeting for the anticipated costs of bringing the space up to City and ADA compliance and installing fire doors. The business now had little choice but to re-approach the landlord about either cancelling the lease (something the landlord was not likely to do) or request additional concessions–not an easy conversation to have after the ink on the lease is dry! The alternative would be to deal with the more-than-anticipated costs of the build out or breaking the lease altogether and ending up in risky and costly litigation with landlord.

If you are a business that is planning on leasing and your business has very unique needs or space requirements, do not hesitate to bring your general contractor along to “kick the tires” on the space as early in the process as possible–and certainly before you sign anything. A good, professional GC should have no qualms about doing this for you. Doing so will not only help your business discover issues with the space that could have a significant impact on your decision to rent but will also be helpful in the budgeting for tenant improvements during current negotiations with the landlord.

Ben Bhandhusavee is the Managing Attorney for BhandLaw, a Phoenix tech law firm that works with start-up companies, intellectual property matters, and complex business and technology transactions. Ben can be reached at (602) 678-2970 or by e-mail at bbhand@bhandlaw.com