Expert: Jim Avancena, CPM - 10/23/2008

Question
QUESTION: My wife and I have a built out office in a professional/medical building. It would be great for a chiropractic clinic or psychologist office. We can not afford the office any more. We never had an office before. The lease is up in March. What options do I have? Can I recover my build out cost some how?

ANSWER: Leo-

I am sorry to tell you that you have very little chance of recovering any of your original build out costs for your office.   When your lease expires in March the premises revert back to the property owner - including the improvements you made to the office.  You are not allowed to disassemble your improvements and take them with you.  If you have any equipment that you installed that is not affixed to the walls or floors of the office, the residual value of that equipment may bring you some value sold as used equipment.

Note that some leases contain a provision that gives the landlord the right to ask you to return the premises to a certain condition upon lease termination.  You will need to review your lease to assure yourself that there are not any similar provisions in this regard.

Do not feel alone, I am afraid that there will be many tenants in the near future that will be unable to afford to pay the rent on their suite given the problems that will accompany the coming economic changes.

Good luck.

-Jim

---------- FOLLOW-UP ----------

QUESTION: Thanks. Then it is not the practise to sell out to some one?

If I could renew and then sublease,  could I possibly recover some money

Answer
Leo-

No.  The chances are that you could end up losing even more money.  You might be mixing up selling the residual business value or remaining good will from your business ("selling out to someone")  with subleasing at a profit; which in your case is more like speculation.    

Similar to the way you are thinking; if the landlord can get a higher rental rate for your leased premises when your lease expires because you have spent your own funds to improve it, expect the landlord to put your premises on the market at a higher rental than similar space in the project that is not improved as well as your space.   

Whether you pay the landlord the higher rental rate in the renewal lease, or some other tenant rents the premises for the higher rental rate, really doesn't matter to the landlord (provided both you and the other tenant offer similar benefits: good credit worthiness, both are complementary to the overall property, etc.).  The landlord simply wants to get the best economic deal for himself that is possible.  You should expect that he will compete with you to lease your space so that the landlord ends up with the rental profits instead of you.  The landlord usually has more leverage than the prime tenant does.

Your idea of recovering some amount of your tenant improvements  expenditures by renewing your lease and subleasing at a profit is a high risk undertaking.  Finding a solid, highly credit worthy and experienced business operator that is seriously interested in sub-leasing your premises at a rental rate that exceeds what your lease renewal rate will be, and for a lease term that is coterminous (matches) with your renewal lease term, is only the first of many hurdles you must navigate successfully to gain the funds you seek.  

Rule No.#1 is that you don't do anything that allows your landlord to figure out that you are planning to sublease your premises before the new lease is executed.  This will be very difficult to do.  Landlords have a sixth sense that sets off a subleasing alarm.  The landlord will likely figure out what you plan to do by the changes you request be made to the text of the landlord's standard form lease.

Do the terms of your renewal lease allow you to sublease?    If yes, does your lease allow you to make a profit from subleasing your premises, or does it require that you pay any profit you make on the subleasing rental rate to your landlord?  Many leases require that your landlord first be given the opportunity to negotiate directly with your proposed sublessee to try and come to terms on a direct lease and then release you from your renewal lease.    

Once you come to terms with a prospective sublessee, does your landlord have the right to reject your subtenant for certain reasons delineated in your lease?   Does your renewal lease require that your landlord be reasonable about rejecting your prospect?   Will your proposed subtenant wait for your sublease to be approved until the landlord is finished negotiating with another prospect that is also interested in leasing your premises?  

Most leases require that the prime tenant (you) remain liable and guarantee payment of the rental stipulated in the lease even if your sublessee goes out of business.  Do you want to take the chance that you might have to start paying the rent required on your renewal lease again if your sublessee gets divorced and moves to Bora Bora?

You must be certain that you negotiate your renewal lease with your landlord such that all the consequential lease provisions are drafted in the way that is optimal for you to be successful subleasing your premises at a profit.  This is very difficult.  Even if you are successful with the drafting of your lease, you also take the risk that your sub-tenant's business viability will not be compromised in a very challenging economy.

Furthermore, when and if you are satisfied that the terms of your new lease will enable you to sublease your premises to your prospect, it is prudent for you to minimize your risk by first having an ironclad understanding with your prospective subtenant that they will sublease your premises at the rental rate (profit included) you need BEFORE you bind yourself irrevocably to a renewal lease.  You can't take the risk that you will commit to the renewal lease and then your prospective sublessee decide they are no longer interested!

You can take the chance that all the necessary parts will fall into place and you will recover all or some portion of the funds you have previously expended improving your premises.   Sometimes it happens that way, but the odds are stacked against you.    

Finally, if everything blows up in your face and the final documents don't deliver the results you expected, consider that a lawsuit could make this process into a costly nightmare.     

You need more than luck.  I urge you to skip this adventure.

-Jim