Leases for commercial real estate remain essential to most businesses, even in a marketplace still reeling from the COVID-19 pandemic. However, the fine print in these important documents is often overlooked in exchange for a quick close with a smiling broker. Most enterprising business owners are ready and eager to set up shop and get down to, well, business. This eagerness sometimes comes at the cost of major concessions or oversight when negotiating the commercial lease. The purpose of this article is to introduce a few concepts that KVK’s real estate attorneys grapple with in practice so that the reader is armed and ready for the next lease negotiation

 

The Big Considerations

 

The Big Considerations

Rent and Security Deposits are where most businesses focus when entering into a new lease. There is good sense in this: these are often the only monetary terms in the entire document, and are expressed with dollar signs which make them easily quantifiable. Of course, the business must determine that the rent and security deposit is within its budget and comports with its long term growth goals. A Letter of Intent or “LOI” is a helpful reference to ensure that the lease document reflects the terms as they were agreed at the proverbial negotiating table.

Important additional issues to consider when negotiating rents are tenant improvements and whether they will be constructed by the landlord or tenant. If constructed by the tenant, it is typical for the tenant to receive a significant abatement on rent during the related build-out period. Be liberal with your estimates on construction timelines and budgets.

Taxes

The lease should also clearly describe the responsibility for real estate taxes and whether these amounts are paid by the landlord or tenant. Cannabis industry landlords typically desire NNN – or “Triple Net” – leases, and call for the tenant to be responsible for all operating expenses in addition to the “Base Rent” payable under the lease.

Taxes represent a significant additional expenditure for a commercial tenant. Exposure for all measure of taxes during a long term lease is often overlooked. When did the landlord acquire the property? Might the landlord seek to sell the property during the lease? If so, the tax basis would be reassessed and a jaunting increase in annual taxes might result. Consider other triggers that may occur during the lease term and negotiate for provisions that clarify the responsibility.

Insurance

Insurance requirements can also be overlooked by a business eager to quickly get into a lease and start operating. By failing to negotiate for reasonable insurance provisions, a tenant-business may be subject to provisions that require that it be overinsured, pay premium rates for low deductibles that are unneeded, or provide one-sided benefits such as rental interruption insurance.

 

Cannabis Business Specifics

 

Cannabis businesses and the landowners that lease to them have particular considerations when negotiating their leases. Be armed with these considerations when first negotiating.

Zoning:

Understand the zoning requirements particular to the locale. Most leases call for the property to be taken in its “AS-IS” and “WITH ALL FAULT” condition. Consider the zoning requirements which apply to the use prior to lease execution.

Application Processes:

Many application processes for cannabis licensure in the state of California require that the applicant demonstrate that it has entered into a lease with a willing landlord who can attest with personal knowledge regarding the cannabis activity that will take place at the site. This puts “the cart before the horse” since most jurisdictions put a cap on the number of available licenses, and license applicants are not guaranteed to obtain a license due to their limited availability. Incorporate provisions which relate to the application process, the related timelines, and the likelihood of obtaining the necessary licenses as reasonable contingencies.

Mortgages:

Properties encumbered by traditional financing liens may not be suitable for cannabis businesses. This is because most standard Deeds of Trust are violated by permitting a federally illegal activity to occur onsite. Wall Street banks may place the property owner in default and institute foreclosure proceedings if the use is discovered or disclosed, thus prejudicing the tenant-operator. A landlord with a traditional mortgage should be prepared to indemnify the cannabis operator from any adverse action brought by the lender or other superior interest holder.

Covenants, Conditions & Restrictions of Record (“CC&Rs”):

Properties subject to publicly recorded CC&R’s require close scrutiny by commercial tenants. These documents are particularly relevant in cannabis leases as they often include restrictions against so-called illegal activity which are enforceable by a wide-range of stakeholders including neighboring properties within the common development. The distinction between federal illegality, and state-legal commercial cannabis activity is an area ripe for dispute and litigation should the landlord or tenant be subject to restrictive enforceable CC&R’s.

Legality and Choice of Law:

In the same vein, almost all standard leases forbid illegal activity from occurring on site. Care should be taken with these standard leases to describe federally illegal activity as the offending conduct.

Particular uses give rise to particular needs during the negotiation and term of a lease. Cannabis uses are no different and, in fact, call for many unique industry issues to be considered prior to lease execution. The foregoing constitutes a mere sampling of the many issues that the real estate attorneys at KVK consider when assisting in the preparation of commercial leases.

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