Avoiding Common Pitfalls of Commercial Real Estate Contracts
Whether you're leasing a space for a new business or purchasing property for investment purposes, the terms and conditions outlined in these contracts will have long-term implications for all parties involved.
Given the challenges of these agreements and the significant financial stakes, knowing how to avoid common pitfalls is essential for any business owner or investor.
As an experienced commercial real estate attorney, you can count on me, Laird Morgan, to help you mitigate risks when establishing your commercial real estate contracts. Here's what I recommend my clients in Collin County, Texas, to avoid when it comes to common contract mistakes.
Lack of Clarity in Lease Terms and Conditions
One of the most common pitfalls in commercial real estate contracts, especially in leases, is vague or unclear terms. This is especially true when it comes to the length of the lease, renewal options, rent escalation clauses, and maintenance responsibilities.
If these terms aren't explicitly outlined in the agreement, it can lead to costly disputes down the line. Some ways to help avoid this pitfall include:
Defining lease term and renewals: Make sure the lease specifies the exact start and end dates. If there are renewal options, these should be clearly outlined, including how notice must be given and whether there are conditions for renewal.
Clarify rent escalation clauses: Rent escalation clauses can be tricky. A tenant might be surprised by the increase in rent over time. Commercial leases in Texas often include provisions where the rent can increase yearly, either through a fixed percentage or based on the consumer price index (CPI). Be specific about how the rent will increase and whether the increases are tied to any indices or market conditions.
Explicit maintenance and repair responsibilities: One area where confusion can arise is the allocation of maintenance responsibilities. Leases often contain provisions for the tenant and landlord’s responsibilities for repairs, maintenance, and property upgrades. Make sure that the agreement specifies exactly who is responsible for common area maintenance (CAM) and repairs to major systems like HVAC, plumbing, and the roof.
Before signing any commercial real estate contract, due diligence is crucial. This is especially true for those purchasing or leasing commercial properties in Texas, where property conditions can vary widely depending on the location, age of the building, and previous ownership.
Inadequate Due Diligence in Property Condition
Skipping a detailed property inspection and failing to conduct thorough due diligence may result in undiscovered structural, environmental, or regulatory issues, which could lead to significant expenses or operational disruptions. Some ways to avoid this pitfall include:
Conducting thorough inspections: Hire a professional inspector to evaluate the building’s structural integrity, electrical systems, plumbing, and more. Make sure that you're fully aware of any potential maintenance or repair needs before finalizing the contract.
Examine property title and zoning: In addition to inspecting the physical condition of the property, it’s essential to check the title to make sure there are no encumbrances, easements, or other legal issues that could hinder future use. Similarly, verify the zoning laws in the area to make sure the property is suitable for your intended purpose. Reach out to your commercial real estate attorney for a professional opinion.
Environmental assessment: In Texas, commercial real estate may have environmental considerations, such as proximity to floodplains, the potential for soil contamination, or prior industrial use. A Phase I Environmental Site Assessment (ESA) can identify potential environmental hazards that may require remediation.
Commercial real estate contracts often require long-term commitments, particularly for leases. It's important to take these into consideration when doing your due diligence.
Inconsistent or Unclear Exit Strategies
Business owners or tenants may find themselves locked into agreements for many years, which can be problematic if their circumstances change. Without an exit strategy, terminating the contract early could lead to financial penalties or a complicated legal process, even with the help of a commercial real estate attorney.
To help avoid this pitfall, consider:
Defining early termination clauses: Make sure that the contract includes a clear early termination clause, which specifies the conditions under which either party can terminate the agreement before the lease or purchase terms expire. This might include circumstances like financial hardship, business closure, or change in use.
Include assignment and subletting provisions: Commercial tenants should negotiate for the ability to assign or sublet the space to another party. This is especially important if your business needs change, and you no longer require the space. Having this flexibility could help avoid paying rent for a space that's no longer in use.
Knowing the full cost of leasing or purchasing a commercial property in Texas is also a critical point of consideration.
Failure to Understand Lease or Purchase Price Components
Many commercial real estate contracts include hidden costs that may not be immediately obvious. These might include property taxes, insurance, maintenance fees, and other operating expenses that can add up quickly. To avoid leaving one party surprised by additional costs or obligations down the line, consider:
Breaking down all costs in the contract: Make sure that all costs associated with the property are clearly outlined in the contract. This includes base rent, operating expenses (such as property taxes and insurance), maintenance fees, and utilities. Commercial leases in Texas may include “pass-through” costs where the tenant shares in the operating costs of the building, so make sure these costs are clearly defined.
Negotiating a cap on increases: Some commercial leases may have provisions that allow for increases in operating costs, particularly those related to taxes or maintenance. It’s crucial to negotiate a cap on these increases or a formula that limits their escalation.
Of course, disputes are almost inevitable in the course of any business transaction, especially in real estate deals.
Neglecting the Importance of Clear Dispute Resolution Clauses
Commercial real estate contracts should clearly outline how disputes will be resolved to avoid costly litigation. This is especially important in Texas, where litigation can be expensive and time-consuming. To help clarify how these disputes may be handled, consider the following:
Including a dispute resolution mechanism: Commercial contracts should include a dispute resolution clause specifying the methods for resolving conflicts, such as arbitration or mediation. These methods are often quicker and more cost-effective than traditional litigation.
Specify jurisdiction and venue: If arbitration or mediation doesn’t resolve the dispute, the contract should specify the jurisdiction and venue for any potential litigation. In Texas, this would typically be a local court that has jurisdiction over the area in which the property is located. Having this defined in advance can avoid confusion and jurisdictional disputes.
On the topic of disputes, Texas is prone to a range of natural disasters, including hurricanes, flooding, and tornadoes, which makes insurance particularly important.
Overlooking Insurance Requirements
Failing to specify proper insurance requirements or not determining adequate coverage can leave property owners or tenants exposed to significant financial risk in the event of unforeseen incidents. To avoid making this error, consider:
Assuring adequate coverage: Commercial real estate contracts should clearly outline the types and amounts of insurance required, including property insurance, general liability insurance, and flood insurance if the property is in a high-risk area.
Review exclusions: Carefully review any exclusions in the insurance policy, particularly regarding natural disasters, vandalism, or theft. Make sure that the insurance coverage is comprehensive and meets the needs of the tenant or property owner.
Avoiding common pitfalls in commercial real estate contracts in Texas requires careful attention to detail and a thorough understanding of the terms and conditions being negotiated.
Always consult with an experienced commercial real estate attorney when engaging in a real estate transaction to determine the best possible outcome.
Contact a Commercial Real Estate Attorney Today
If you're looking to establish a commercial real estate contract, don't hesitate to contact me, Laird Morgan, Lawyer, for an experienced commercial real estate attorney you can rely on. I serve clients in Richardson, Texas, and throughout Collin County. Contact me today to schedule a consultation.