It felt like I had a gun to my head. Either lease up one of the most unpopular rundown buildings in Alberta or go bust.
We made a classic real estate “newbie” mistake. We bought a building based on the wrong assumptions and fooled ourselves into believing we could easily lease it up. Because we had no revenue, we were barely making the mortgage payments. We had to renegotiate the mortgage terms.
The problem, however, was that the mortgagee wouldn’t even take our calls until we demonstrated cash flow (i.e. signed leases). We had none. We were desperate.
That’s when we made another classic real estate newbie mistake.
Why you have to care about exclusive use clauses:
Our goal was to stay afloat. We were thinking of the short term, so we were okay giving away the kitchen sink in exchange for a signed deal. In our haste to attract tenants we agreed to exclusive use provisions, which didn’t seem like a problem until…
I got a call from an irate, but very important and influential tenant. He says we violated the lease and he was treating the lease as terminated. He’s moving out in 30 days and not going to pay us a single dollar more.
The irate tenant, a dermatologist, was livid because we signed a lease with a plastic surgeon. He claimed that the surgeon’s services were infringing upon his exclusive right to provide cosmetic services, as per the terms of the exclusive use provision we agreed to and memorialized in the lease.
If this tenant was right, we’d lose him and limit our market for new tenants.
In our haste to get the deal done, we didn’t care about the language we used in our exclusive use provisions. The agent believed that we had an understanding that the clause was to be narrowly interpreted. A violation would only occur if we leased a space in the building to a dermatologist. After all, that’s really the only true direct competitor…right? Wrong.
What is this clause and why does the tenant want it?
The health of a business depends on a lot of factors – one of the most critical is ensuring that you stay ahead of the competition. It just makes smart business sense, then, to make sure a landlord isn’t permitted to lease out a space to one of your direct competitors.
To prevent a competitor from opening up across the hall, tenants demand that an exclusive use provision be included in the lease. And landlords are typically willing to oblige. This is because landlords want to maintain a complementary tenant mix. A good mix attracts more consumers, which makes the tenants profitable and, therefore, more able to make their lease payments.
“Landlord represents, warrants, and covenants that from and after the Effective Date, neither Landlord nor any Landlord Affiliate will lease any space in the Building (except the Premises hereby demised) as the same may now exist or as now being reconstructed or as enlarged or altered at any time in the future […] or permit the use or occupancy of any such space, whether at wholesale or at retail, to any tenant or other occupant which sells, or displays for sale or provides services in any one or more of the following: cosmetic services.”
This very broad clause makes the landlord promise that it will not lease any spaces in the building to anyone who will carry on any sort of business related to cosmetic procedures. This includes tenants that currently exist or those that may exist in the future.
What should you do?
A quick tip when you have lower negotiating power than your opponent – arm yourself with information and always offer to draft the document; this provides you with control over timing and clarity as to what you can and cannot give up.
Avoid my calamity by following these three (3) steps:
1. Very narrowly define the nature of your tenant’s business
In the example above, it would have been wiser to replace the term “cosmetic” with something more specific. For example, instead of saying that the tenant has an exclusive on performing cosmetic procedures, say that the landlord will not lease out the space to another dermatologist.
An even better approach is to get even more granular on the definition. For example, limit the right to dermatologists who specifically serve a particular population or provide a niche service. Such specificity is very important in today’s highly segmented specialty retail and services market. Consider the fact that we see popular chains that specialize in the sale of organic cold pressed juices, tea or gluten free cupcakes. If you give a coffee shop tenant exclusive control over all hot and cold drinks and desserts sold in your shopping centre or building, then you’ve effectively prohibited yourself from leasing a space to a speciality tea store, bar, restaurant and bakery.
2. Allow for incidental sales
In our example above, we should have allowed for other tenants to perform procedures that are typical to a dermatologist only if those procedures are incidental and not the main source of other tenant’s revenue. In other words, Botox would have been permissible for the surgeon to perform. This is because Botox is not what the surgeon does for his main source of income.
3. Be precise about who is a direct competitor
It comes as no surprise that a tenant wants to ensure that the landlord doesn’t lease out the space to direct competitors. Take great care to define those well. Make your tenant tell you who its direct competitors are and memorialize that in your lease. In our example, state in your lease that your tenant’s competitors include the specific names of dermatological chains.
To ensure that the list isn’t too cumbersome, make sure to provide that those competitors must exceed a certain square footage threshold, like 2,000 square feet, to be considered your tenant’s direct competitors. Finally, make an exception allowing tenants in the building to assign their leases or sublet their space to direct competitors of your new tenant if the other tenant’s leases predated your new tenant’s lease.
Even when facing time constraints, take a moment to critically think about how today’s decisions affect tomorrow’s ability to grow. Keep this in mind as you negotiate and draft a lease. While the wording may not be perfect, it is better than having a lease that fails to address those at all.