As either a new or existing commercial tenant, you may be tempted to prelease undeveloped property (to open a new business or to move your business). As we explain in our book, Negotiating Commercial Leases & Renewals FOR DUMMIES, this is potentially the most unpredictable lease agreement for a tenant to enter into. Why? The answer is simply because you are making a long-term leasing decision based on little more than a hole in the ground and you can’t visually assess the property or physically touch the bricks and mortar.
Consider the Pros and Cons
Often in these types of deals, the commercial tenant is required to make a long-term leasing decision and commitment based only on the landlord’s design drawings—which the landlord can typically unilaterally change. We remember one prelease deal where the landlord not only changed the colour scheme and exterior look of the property (so as to save money) but also did so against the wishes of all the tenants who had signed up to date. Preleasing also means there are no existing tenants to talk to about how their business is doing within the property (as there are no tenants open for business yet).
On the other hand, some of the best leasing locations are prelease opportunities or new properties under development, especially if the physical location or land is well situated. The Lease Coach has successfully completed many prelease deals for our clients with excellent long-term results. Just keep in mind that landlords often reserve the right to make changes to your unit without tenant consent. This can affect the size, shape, and physical location of the tenant’s desired premises as well as the building itself or even the grouping of buildings.
How to Reduce Your Risk
One trap to avoid is signing the lease agreement and then waiting months while the landlord tries to finish leasing up the property. Some landlords won’t—or can’t afford to—start construction until they hit a set percentage of done deals or leased space. The agreement with the mortgage holder may be that once the landlord gets signed lease agreements for 50 or 60 percent of the property, the funding package is approved and finalized, and then (and only then) the property can be built. Ensure that you have a termination date in the event the commencement of the development is delayed beyond a reasonable timeline or your requirements.
Another risk to avoid is where the landlord decides to move forward with the development but has only secured a handful of tenants. This will result in a property with many vacant units, which may not be appealing to potential customers nor encourage them to visit. To be successful, a proper tenant mix and synergy is required—especially for retail plazas. Again, you can look to include in your contract a right of termination in the event that there is not a certain level of preleasing achieved by a specific date. Alternatively, you can negotiate to have your rent commence in full only once the tenancy reaches a predefined level.
Prepare for the Unexpected
If you’re one of the first tenants signing a prelease deal for a new development, you may be disappointed with your new neighbouring tenants. The marketing material for the new commercial property may show a great mix of potential tenants; however, this is only a wish list for the landlord. If a specific anchor or other tenant fails to materialize, this obviously affects your site selection process and even the rental rate you’re willing or capable of paying at that property. As one of the first tenants in a new property, also think of the potential headaches for visiting customers. No matter how enticing your business will be, these people may not want to navigate a construction zone just to get to you.
In closing, remember that the biggest challenge in this situation will be anticipating unknowns (e.g. timing, other tenants, the final product built). The more you can anticipate for some of these potential hurdles through strong planning and a well-negotiated lease, the better your opportunity to end up with a strong lease in a desirable new commercial property.