John S. Kim
Editor’s note: John Kim, Esq., is principal at Miren.Co, a commercial real estate brokerage, and Co-Founder of Opodz, a co-working space in Downtown Los Angeles.
Good startups grow. Great startups grow smartly, with a watchful eye toward an unrestrictive future. Naturally, however, even the most brilliant of startups have blind spots in their management. One such blind spot is in the area of commercial real estate, where growing startups often risk entering into creative office space leases that could stymie their growth, anchor them in their race against the competition, or altogether crush them with debt.
That said, as someone who’s represented the interests of both landlords and tenants, I thought I’d share some important points for growing startups to consider in order to avoid hurting themselves when leasing these less traditional spaces.
“Creative office space” comes in all shapes and sizes, but its underlying commonality is that it strays from traditional layouts, and it imposes unusual, inconsistent utilities and security demands upon landlords. Therefore, when negotiating with startups, landlords are understandably trying to protect themselves from the unknown via various deal parameters, and here are three important ones for startups to carefully consider:
The Triple N Lease
“Triple N” is a term that startups had better learn quickly, because it’s fast becoming the paradigm for leasing to them. The triple N lease essentially requires a tenant to pay a base lease rate, plus pay for their services, utilities, taxes, insurance and management in accordance with their proportion of the property’s size/facilities.
In other words, whereas a traditional full-service gross lease covers most services and utilities (not phone and Internet), with the assumption that your employees will only be there during regular business hours, in a triple N lease, the landlord is effectively passing through their costs of serving you in an almost proportional or on-demand fashion.
For example, if you were looking at a 10,000 sq. ft. space, and a landlord offers you $2/sq. ft. base rent with $1/sq. ft. triple N charges, that makes your total costs $30,000/month ($20K base + $10k triple N).
This is, of course, a smart way for landlords to protect themselves from startups’ variability, but it also means that growing startups will need to ask themselves what their culture and employee habits are and will be during the term of the lease. Otherwise, startups risk committing themselves to service rates, layouts, etc. that might hurt them, financially and/or strategically, down the line.
Hence, if you cannot confidently answer these questions of culture or employee habits, or if you need help systematically asking yourself the right questions, a commercial real estate broker or agent with some creative office space experience can help you here.
Tenant Improvements
Another leasing parameter for startups to be especially cognizant of is tenant improvements, or the degree to which a landlord and a lessee split up the responsibility of improving the tenant’s space before and during the life of the lease. Startups should be vigilant here, because creative space layouts are not yet the norm, so landlords and their architects aren’t always familiar with the configuration needs or preferences of creative space tenants.
If you or your broker/agent aren’t careful, your landlord or their architect could waste a lot of time proposing mostly run-of-the-mill layouts, which probably won’t cultivate the kind of aesthetic or culture that would support your strategic interests in hiring, creativity and productivity.
Also, when divvying up the responsibility for improvements, startups might be surprised to learn just how much many of these improvements cost. For example, floor to ceiling glass walls such as those used in modern conference rooms, will cost much more than conference rooms composed of glass and drywall. And this usually isn’t the landlord’s fault. It simply costs that much for quality, insured labor and materials these days.
Still, if you do your homework or simply make sure to retain an experienced broker/agent, there are savings (including time!) and beautifully conducive layouts to be had. Just bear in mind, when asking landlords to improve your space for you, they’re usually going to keep an eye on your effective rental rate, after costs.
The Term
Naturally, the longer your potential lease, the more leverage you’ll have in lease negotiations, and that could certainly benefit you on the parameters above. This point seems like a no brainer, but you’d be surprised to find how often tenants do not systematically think through the financial and strategic implications of their possible term(s).
Primarily, when discussing a longer-termed lease, if the size of the space in question might not accommodate your projected human resource count, movements, and culture, you should seriously reconsider the size of the space you’re hoping to lease. Otherwise, of course, you risk breaking your long-term lease, which could be quite costly.
If your startup cannot reliably project its financial or human resource growth, you or your broker/agent should try negotiating option rights with your landlord. Option rights, like the right of first refusal or the right of first offer or extension options, effectively make a lease’s term for a specific space more flexible by giving tenants the option to secure additional space, or to extend their current lease, when they are ready.
Of course, getting a landlord to give you such rights could affect the remaining terms of the lease, and/or they might simply not have the additional/optional space available, but it’s definitely worth a shot for growing — or busy — startups to secure some size flexibility.
Granted, there are more lease deal parameters that a growing startup could consider, and there are more potential nuances to the above than I could possibly fit into a single post. It is my hope, however, that the above will give growing startups enough insight to avoid making some oft-repeated financial and strategic mistakes when leasing creative office space.
As for securing the optimum lease, or checking whether a “standard” lease offer is truly so, if your management team is not yet ready to learn all of the ins and outs of commercial real estate regulations, norms and local area players, it’d behoove you to seek the services of a commercial real estate broker or agent.
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