Trick or Treat? The Pros and Cons of Being a Commercial Tenant or Landlord in California

Posted by: kevensteinberg
Category: Areas of Practice, Blog, Real Estate Law
Pros and Cons of Commercial Landlord Tenant

Whether you are a small business and are looking at commercial property to rent or you’re a landlord looking to lease your property, the tenant-landlord relationship will be an integral part of your life.

In commercial spaces, landlords provide a much needed resource. Given the right circumstances, the relationship between a landlord and a tenant can be mutually beneficial. 

But even the best tenant-landlord relationship can run into problems. Like a costume on Halloween or a haunted house, lease agreements and rentals may not be as they seem. And knowing the tricks and treats of being a landlord or being a tenant can help both parties better understand each other and recognize how common disputes arise. 

Taking Off the Mask: The Pros and Cons of Being a Commercial Landlord in California

Being a commercial landlord can be an excellent source of income, but it also has significant pros and cons. Let’s look at some of the most common tricks and treats of managing a commercial property. 

Treats: The Pros of Being a Commercial Landlord

  1. The investment value and tax advantages of property ownership.  Being a property owner has historically provided and continues to provide great investment opportunities and tax advantages, especially in California, where property values reguarly go up in value in double-digit and sometimes in triple-digit percentages over time. While property owners eventually benefit from this return on investment, they can then carry that benefit over to other properties in IRS 1031 exchanges and may also enjoy many tax write-offs during ownership.
  2. The potential returns in profit and income from a commercial property are higher than residential. Commercial properties have the potential to greatly increase in property value; if it is maintained well and the timing is right, owners can sell for millions more than the original purchase price. Commercial properties can charge higher rents than residential properties, and those rents may increase over time depending on the growth of the area. Commercial tenants also sign longer lease agreements, generally at least 5 years in length because they too are investing money into the storefront or office building and benefit from the stability of a longer lease. With a long-term commitment and the potential for higher rents, the potential return on investment for the landlord is high.
  3. Commercial landlords have more flexibility in lease terms. There are fewer laws to govern commercial leases. For example, in a residential property, the property must be habitable, but commercial agreements don’t have that same requirement. These differences can put more responsibility on the tenant, making the job of landlord a little easier. However, you should always stay up-to-date on current California civil code to ensure your lease agreements are compliant with law. 
  4. Retail and commercial tenants typically have a vested interest in maintaining the property. Because retail and commercial tenants want to attract customers or employees to their space, they generally take steps to maintain or even improve the appearance of the property, helping to ensure your investment retains value. And because the tenants are typically businesses, the relationship between tenant and landlord can be a business-to-business relationship, remaining more professional and courteous rather than personal. 

Tricks: The Cons of Being a Commercial Landlord

  1. The start-up and maintenance costs are significant. Acquiring a commercial property typically costs more upfront than a residential one. And although you can include CAM maintenance fees (“Common Area Maintenance” costs, expenses, and fees dealing with the shared spaces in the building, such as maintaining the building security system) as tenant responsibilities, you may still have building maintenance costs after that initial cost of purchasing the property. You may have renovations to make or security features to install before leasing the space or there may be maintenance issues that come later like roof repairs, plumbing repairs, emergency damage repair, or safety code upgrades. 
  2. Commercial properties are vulnerable to changes in the economy. Commercial properties are especially vulnerable to dips in the economy as we have seen with the COVID-19 pandemic. When businesses are forced to close or their business slows, they may stop paying rent. In the COVID economy, some commercial tenants have tried to get out of or renegotiate leases because of the slowdown. 
  3. Commercial properties have more risks. Commercial properties have more public visitors than residential properties. With more people on the property, there is also an increased chance of damage, injury, or accidents. Commercial landlords should be aware of this increased risk and liability and prepare for any potential legal disputes. 

Pros and Cons of Being a Commercial Tenant in California

Whether you are looking for office space or you need a retail property for your small business, there is a good chance you will choose to lease a commercial space rather than buy. And just as there are pros and cons to being a landlord, there are pros and cons to being a commercial tenant. 

Treats: The Pros of Being a Commercial Tenant

  1. Tenants don’t have to worry about a large down payment or upfront investment. While tenants are typically responsible for security deposits and other upfront leasing fees such as a broker, an inspection fee, and a lawyer, those costs are significantly less than the cost of a down payment for a commercial property. And with the fixed monthly rent for the duration of the lease, the cost per month is predictable. 
  2. Leasing provides more options for locations. In many developed areas, there are more options for leasing than buying. You may be able to lease a space in an area where you couldn’t afford to buy property, giving you more options to find the best space for your business. 
  3. There is more flexibility with a lease. With a commercial lease, you have the option to move to a new space when your lease is up if your company grows and needs room to expand. With a lease, you’re not locked in to a mortgage. 

Tricks: The Cons of Being a Commercial Tenant

  1. Rent can be expensive. In some areas, the cost to rent may even exceed the mortgage rates. If you have a triple-net lease agreement, a common type of lease, you may also be responsible for retail insurance, property taxes, and utility and maintenance costs. You may also see large rent increases when it comes time to renew the lease. 
  2. You don’t benefit from any equity increase. Since you don’t own the property, you won’t benefit from any appreciated value over time. If you make improvements out-of-pocket to your space, such as wall finishes, plumbing additions, or other improvements that cannot be moved to your next space, that added value will go to the landlord. 
  3. You have less control over the property. Tenants do not have control over who the other tenants will be, rent increases, or other factors. Depending on your lease agreement, it may be difficult to renegotiate an increase in rent or terminate a lease early if you go out of business. This can leave you responsible for rent and other expenses even if you no longer use the space. 

Tips for a Great Tenant-Landlord Relationship

Now that it’s clear how both landlords and tenants face wins and challenges in their business relationships, we can also see how commercial landlords and tenants rely on each other to succeed. Landlords need tenants to make their property profitable, and tenants need space to operate their business successfully. So, what can landlords and tenants do, especially in the uncertain time of COVID-19, to create a mutually-beneficial relationship? Here are some tips

  1. Be honest and communicate. Landlords should be transparent about the characteristics of the property. Landlords should disclose anything required by law, such as lead paint, but they should also be open to answering other questions about the property if potential tenants ask. Tenants should pay rent honestly and on time every month. If they ever foresee an issue with making a payment, communicate that to the landlord. 
  2. Be thorough. Both the tenant and landlord should do their research before signing any legal agreement. Tenants should make sure the property has been inspected and they should know their rights as a tenant in California and make sure the lease protects those rights. Landlords should do some research on potential tenants to ensure the tenant is a good fit for the property and ensure the lease agreement is compliant with California civil codes. Landlords should also make sure tenants have all the information they need to be a good tenant—who to contact for any questions or property needs, when trash day is, rules for parking, and any other important property information. 
  3. Know your responsibilities and relevant laws. Both tenants and landlords should be familiar with California civil codes and commercial property laws. Knowing these laws and regulations will help each party know and protect their rights as property owner and tenant. Responsibilities for tenant and landlord should also be outlined in the lease agreement. An experienced real estate attorney can help make sure each party knows their obligations and rights. 

Don’t Let Your Experience Become a Horror Story: Get a California Real Estate Lawyer on Your Side

With the economic uncertainty of COVID-19 affecting both landlords and tenants, it’s more important than ever to understand your rights and responsibilities as a tenant or landlord. And with potential changes to California civil code and property taxes like Proposition 15 on the horizon, both landlords and tenants need to know how to move forward into 2021. 

Luckily, the experienced team at Steinberg Law is well-qualified to help you with all your California commercial real estate needs. Keven Steinberg has litigated a wide variety of complex real estate cases and has worked with numerous clients to maximize their business opportunities in the ever-changing real estate market. With Steinberg Law on your side, you can be prepared to handle any eventuality and feel confident in your property and lease agreements. Contact Steinberg Law today to get the expert counsel you need.  

Author: kevensteinberg