Sharing Space

by Howard Barewin

Many small business owners acquire larger buildings or offices than they initially require to accommodate anticipated growth.

Under-utilized space gives a business owner the opportunity to generate supplemental income by leasing the area to another person or company. The economics will ultimately dictate whether leasing the space is desirable. Here are some key questions to be asked in exploring whether it is feasible.      

What will it take to bring the space to a leasable condition?

You may need to install a dividing wall, utility upgrades, or other improvements, perhaps even items specifically required by the user. If so, the facility owner typically performs much of this work and fronts the cost. The owner is reimbursed—generally with interest—through supplements to the monthly rent payment. Even if the area is usable “as-is,” the tenant may need to use common parking areas, driveways, lobbies, hallways, break rooms or bathrooms in the building, which could cause disruptions or jeopardize security or confidentiality of records or work product. The lease document can address many of these concerns, but if utility service or heating or air conditioning equipment is to be shared, you may need to install separate meters to properly allocate expenses.  

When do I need the space back?

The small business owner wants to maximize the duration of the rent stream, without jeopardizing his or her ability to recapture the space when the time for expansion arrives. The longer the space can be made available, and the more notice the owner can give before needing it, the more marketable the space. An owner that can assure only a thirty-days notice is unlikely to find a tenant willing to invest the time and effort necessary to operate in the facility.

Are there any outside restrictions that prevent or restrict the transaction? 

Municipal zoning ordinances or site plans may not allow for different uses. If the business owner leases its facility, the landlord has likely reserved in its lease the right to consent to a sublease to a third party, and possibly the right to keep profit derived from the sublease. If the business owner owns the facility, the loan documents may limit the right to allow others to use the facility. And your insurance agent can advise you to make sure the arrangement will not impact your existing policies. 

Unless a ready user has expressed interest, the first resource to help answer these questions is a reputable commercial real estate broker who specializes in the type of operation to be sought—retail, office, or industrial. The broker can assess the market-ability of the space, gather data to evaluate the economics of a deal, and provide referrals or ideas to resolve potential hiccups. The broker can market the space, but be wary of exclusive arrangements that run beyond six months. Once specific prospects are identified, the broker should help evaluate the investment required to make the deal, and the return on that investment. Of course, one impact on the return will be the broker’s commission, which is paid upon signing a lease and customarily runs 6% of the rent for the term of the lease. Before selecting a tenant, make sure the tenant has acceptable financials, and do not hesitate to ask for a personal guaranty from a company tenant’s individual owner.

Once the main terms are agreed upon, a landlord and tenant may sign a letter of intent, or they could move directly to execute a lease. Leases tend to be lengthy legal documents because they strive to eliminate potential disputes and allocate risks and responsibilities over long periods of time—usually no less than three years in the commercial context and sometimes twenty-five years and beyond, with options. Contact an experienced real estate lawyer for a lease document that is consistent with the deal’s magnitude and complexity, one which covers the business points and repair, insurance, default and other typical obligations appropriately but without overkill. A good lease at the outset will help avoid many “gotchas” and help cement that new income for years to come.

Howard Barewin is a partner at Blackwell Sanders LLP.
P     |     816.983.8218
E     |     hbarewin@blackwellsanders.com