A Right of First Offer (“ROFO”) requires that the property owner (a “Seller”) give the holder of the ROFO (often the tenant) the first chance to buy the property before offering the property to a third party. The right holder has a specific amount of time to make an offer before the right expires. If the holder of the ROFO does not exercise their right to lease or purchase, the Seller can proceed in soliciting offers from third parties. The ROFO is a “first look” right often executed between the Seller and tenants, business partners, or other interested parties. However, simply holding a ROFO does not guarantee the sale of the property to the ROFO holder. The Seller is free to reject the offer and proceed with selling to a third party if an agreement cannot be made.

By contrast, the Right of First Refusal (“ROFR”) is a “last look” right that comes into play when a Seller receives an offer of purchase on its property. If the property is subject to a ROFR, the Seller must grant the holder of the ROFR the opportunity to purchase the property on the same terms and conditions offered by the third party. In this instance, the holder of the ROFR is compelled to make a purchase or leasing decision based on the terms previously negotiated by the third party. Assets with a ROFR attached can be more difficult to sell, because potential buyers may not want to go through the trouble of negotiating a deal that must be offered to another party first.

For sellers, the implications of an underlying ROFO or ROFR should be considered in advance when there is a desire or an effort to sell property. Failing to strictly comply with the terms of the ROFO and ROFR may render a seller liable for economic damages and cause other unforeseen consequences. If, for example, a Seller proceeds to enter into a purchase agreement with a third-party buyer to sell the property without strictly abiding by the ROFO or ROFR terms contained within a lease for that property, the Seller is exposing itself to liability from both its tenant and buyer. If the ROFR or ROFO holder elects to purchase the property, the Seller has now contractually agreed to sell the property to someone else and is faced with either breaching a contract or violating the ROFR/ROFO agreement. In practice, this often leads to a monetary settlement that can almost always be avoided with reasonable foresight and diligence.

On the flip side, buyers should also factor in the presence of a ROFO or ROFR in the due diligence phase of a transaction. This will not only alert a buyer to potential failures on the seller’s part to adhere to applicable ROFO or ROFR terms, allowing the buyer to then seek an appropriate remedy, but it will also put a buyer on notice of a continuing ROFO or ROFR that could be relevant in the future should said buyer ultimately assume any agreements with those provisions.

Remaining cognizant of ROFO and ROFR provisions is equally applicable in the context of commercial leasing. The implications of those provisions should not be overlooked by landlords and tenants given the similar liabilities that exist for ROFOs and ROFRs in relation to buying and selling real estate. Ultimately, it is beneficial to be proactive in approaching ROFOs and ROFRs, and whether you are a buyer, seller, landlord, or tenant, enlisting experienced legal counsel can help you avoid potential ROFO and ROFR pitfalls.

For more information or to seek counsel from our real estate law group, please reach out to request a consultation or call us at 216-696-1422.

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The Problem

The COVID-19 pandemic was a difficult period for most Americans, but specifically for landlords and property owners. In the midst of the pandemic where many Americans began working from home, business owners and employees alike began to understand that some people are able to work productively and collaboratively without having to be together in the same office space. It was quickly realized that internet-based communication technologies allowed employees to continue to interact with other individuals, to host or attend meetings with other employees, to make or observe visual presentations; and to participate in work-related webinars. As such, the dramatic reduced demand for leased office space led to a reduction in the market value of many office buildings, which depend entirely on leasing revenue. This in turn led to a rise of office building insolvency and foreclosures. Especially vulnerable to these fates are aging and deteriorating office buildings, buildings located in overbuilt areas or neighborhoods with falling real estate values and rising vacancy rates, and buildings located far from public transit.

A Possible Solution

A recent trend has emerged in which some developers are opting to convert underused or vacant commercial office space into residential communities. In some instances, office buildings are being reconfigured as hybrid buildings, with a few floors dedicated to office space, a few as residential floors, with other retail or hospitality spaces occupying the ground floor, capitalizing on a consistent foot traffic of building residents. The hope is that by converting some of these buildings, property owners can maintain or recover an adequate source of revenue and property investors can preserve some profitability through even a modest return on their investment.

Advantages

There are some advantages to converting abandoned office space to multifamily housing units.  Some of the more notable advantages are:

1. The converted building’s current onsite amenities such as fitness facilities, pools, or restaurants are lucrative property highlights that tenants tend to view highly favorably, and these amenities can often counterbalance tenant concerns about reduced living space.
2. Many office spaces are already located in highly walkable, accessible neighborhoods or are close to large business districts and transportation. This can be very attractive for new tenants eager to reduce or mitigate their commute as more business ease back into pre-COVID attendance practices.
3. By offering a more diverse mix of residential, commercial, and entertainment options through repurposing vacant office space, the  formerly bustling office towers and blighted warehouse spaces that litter many Downtown, USA streets can experience revitalization from the commerce inspired by increased foot traffic and visible occupancy.  These revitalizations of desolate office communities become celebrated stores of economic success for the area, which is a win-win for the developers, owners, and tenants.

Considerations

Though there are some notable advantages that come with repurposing office space into multifamily housing, there are also some important factors to consider before undertaking a building conversion:

1. Zoning.  Commercial property can only be converted into a residential property if zoning ordinances allow it. Local governments have regulations dictating property distinctions and, in most cases, will distinguish specific areas for residential versus commercial land use. If you are looking to make the transition, an early analysis of local laws is essential.  If the property is not zoned for residential use, it may be worth considering applying for a zoning variance or requesting a rezoning designation, neither of which is guaranteed and depends on local conditions. Zoning will be the basis for converting commercial property to residential use and is a necessary first step in the conversion process.
2. Building Code Constraints. There are specific requirements concerning fire and smoke protection, egress paths of travel, access to natural light and ventilation, and occupancy that are required for residential buildings. This means that developers who plan to convert these buildings must ensure that these buildings continue to adhere to any building codes. The property may require rewiring and a new layout to successfully create residential units. Upon completion of the work, a new certificate of occupancy will be needed.
3. Building modifications. With the conversion process, there are bound to be some issues resulting from geometrical differences between what works architecturally for an office building versus the unique needs of residential living. In addition, electrical and HVAC systems may require significant overhauls to accommodate the demand and capacity required by residential living and the nuanced technological amenities that have become standard expectations, such as units that are cable-ready.
4. Feasibility Studies. Residential rezoning of certain buildings may require additional feasibility studies for traffic, stormwater treatment, and other environmental impacts.

When In Doubt, Consult Professional Legal Counsel With Commercial Real Estate Law Experience

The considerations listed above may seem formidable and even insurmountable disadvantages, but owners and developers who have experienced and knowledgeable real estate counsel can navigate and overcome these challenges with relative ease.

McCarthy Lebit’s Real Estate and Construction practice is well suited to handle real estate transactions and development deals involving office, retail, warehouse, industrial and mixed-use properties. Our real estate attorneys can also counsel on condominium, multifamily, and residential development as the property transitions from developer to the property owner, manager or homeowner’s association.

Owners and developers interested in exploring a commercial office building hybrid or complete conversion are encouraged to reach out to book an appointment to speak with one of our Real Estate & Construction attorneys about property availability and financing options.

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1. Are you renting?

If you currently rent your apartment or home, rather than own it, take the time to look through the hefty stack of papers your landlord had you sign prior to move-in. Keep in mind your lease is unlikely to contain specific references to Airbnb, but instead include information about utilizing your property for short-term rentals or “subletting,” which means the tenant rents his or her property to someone else during his or her lease. Your lease may allow subletting, directly prohibit it, or require a signed agreement with your landlord. In addition to thoroughly reading through the paperwork, consult with your landlord to make sure you won’t be creating any violations, and be prepared for the possibility of giving up a percentage of profits.

2. Are you part of a homeowner’s association or condo-owner’s association?

Once again, the document you signed lays out the regulations. If you are a part of a homeowner’s association or a condo-owner’s association, locate the governing documents and take time to read them thoroughly. The terms of these documents may explain whether you can list your unit on Airbnb, and if you can, how long you can do so, among other restrictions.

3. Are you violating zoning provisions?

Every city’s zoning ordinances are unique, so you need to fully review the provisions affecting your home. You may be in an area that your city has zoned to accommodate only single-family residences, exclude use of a commercial property for commercial activity or require a business license. In addition, the zoning code may determine how many renters or rooms rented you may have simultaneously. There could also be regulations for how long you may rent to any one person, whether you must occupy the home while renting it out, or if you can rent your entire home to guests. If you are prohibited from renting the property, you can potentially apply for a variance with the city that will allow you to rent through Airbnb. Keep in mind you may be penalized if caught violating your city’s ordinances.

4. What if someone gets hurt?

Let’s say you successfully list your property on Airbnb and someone gets injured while staying at your place. If you think it will solely be your guest’s fault regardless of what occurred, think again. You can still be held liable as the tenant or the owner in this scenario. You might think nothing serious will happen, but remember, you know the unit better than anyone, including a loose handrail or extra step outside the door. Even if you have homeowner’s or renter’s insurance, your policy may not cover injuries sustained by tenants or incidents occurring on your property due to conducting commercial activity. Consider your insurance policy and the possibility of piling medical bills before you decide to list your property to avoid a financial disaster.

5. Do you know how to account for rent received for tax purposes?

If you are renting rooms within your home in exchange for cash, you need to know what constitutes income; otherwise you can run into problems with taxing authorities. Determining tax consequences is not as simple as it sounds, because you will need to consider factors like: (a) how many days of the year is it rented; (b) do you normally live there; (c) how much of your house are you renting; and (d) what expenses can you claim as deductions? In addition to the amount being considered income, certain city ordinances impose transient taxes for short term rentals. There may be other taxes that apply as well depending on your city’s ordinances. Regardless, you should fully understand the tax consequences prior to renting the unit to ensure compliance and prevent future penalties.

Although the idea of renting out your unit on Airbnb appears to be seamless, there are a number of factors to consider. Contact one of our real estate or tax attorneys today to see how these factors affect you and your potential rental unit.

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Even though renting is less of an investment of your time and finances than purchasing a property, commercial leases should not be overlooked, as failure to understand and negotiate your lease can end up costing you later.  So when you’re handed that lease, here are a few questions you should ask yourself before signing on the dotted line:

• What is the best type of lease for your business? A gross lease is the most traditional type of lease with the tenant paying rent and the landlord paying taxes, insurance, and maintenance expenses. A net lease transfers some or all of the expenses to the tenant. For example, in a single net lease, the tenant will pay the base rent plus property taxes, while a double net lease would include property taxes and insurance, and a triple net lease would include property taxes, insurance, and maintenance costs.
• Is it too expensive? The rental rate states the amount of rent and when it will be paid. Most leases also include late payment provisions that impose additional charges if you fail to pay the rent when it’s due or within a specified grace period. If your business experiences seasonal or irregular sales activity, try negotiating a flexible rental rate that corresponds to the changes in your cash flow.
• Is the lease term flexible? Try not to tie yourself to a long lease term; your business may grow faster than you expect or the location might not work out for you. A short-term lease with renewal options is usually safer. A renewal option specifies whether you have the option to renew the lease when it expires and, if so, specifies the amount of rent to be paid. A renewal option can give your business protection against large rent increases when your first lease term expires.
• Who pays what? You may have additional expenses besides rent, which may include: (a) Common Area Maintenance fees to maintain common areas shared by other tenants within the same building or office space; (b) utilities; and (c) maintenance and repairs of your leased space.
• What improvements can be made? You may want to do make some improvements to retrofit your space to fit your needs. Make sure it is clearly outlined in the lease what alterations you are allowed to make, who is responsible for paying for them, and who will own them after the lease ends (generally, the landlord does).
• Can I transfer my interest? Look carefully at the assignment and subleasing provision to determine if, and under what conditions, you are entitled to assign or sublease the premises to another. Subleasing offers protection if you are no longer able to pay the rent, or if you have expanded to the point where you need to move into larger space. Assignability is also favored for many reasons; one being that if you sell your business, you will want to assign the lease to the new owner.
• What happens if you default? It is important to understand the default process as outlined in your lease. You should negotiate your lease to require written notice followed by a grace period (which allows a cure period to make a late rent or comply with another lease requirement) before the landlord may exercise default rights. There will be consequences once a default is uncured so make sure you read and understand your landlord’s remedies upon default.
• Are you personally liable? Landlords often require a personal guaranty of the lease. If you can’t negotiate the guaranty language out of the lease altogether, and you are willing to risk personal liability, try to limit the guaranty if possible.

These questions are just a few of the many that need to be asked to ensure that your business has the greatest probability for success. While it is important to review and understand the language of your commercial lease, some of the more complicated provisions may be best suited for an attorney who can advise you, and if necessary, negotiate those provisions on your behalf.

The post Commercial Lease Considerations for Small Businesses and Startups appeared first on McCarthy Lebit - A Cleveland/Ohio Law Firm.

You may wonder why you would voluntarily enter into such an agreement, especially when you have no specific lease obligation. As a practical and business-savvy landlord, it is imperative for you to recognize the importance of your tenant’s financial success. To secure that success, the tenant presumably needs the loan to improve its business and generate revenues needed to pay the rent.

Nonetheless, just because you want your tenant to succeed does not mean you should sign any form waiver the lender throws your way. To ensure that your rights as a landlord are properly balanced, you should consider the below:

Waiver vs. Estoppel

You will want to subordinate your lien on tenant’s property rather than completely waive it. Lenders typically agree to subordination, as their focus is receiving a first security interest. With subordination, the lender obtains priority, but your lesser secured position may still provide reduced recovery if the tenant defaults.

Collateral Description

The collateral description should be limited in scope and easily identified, avoiding blanket descriptions. The specificity of the definition will ensure that you do not waive or subordinate rights to property other than what was financed by the lender, including your own property, like real property improvements, plumbing, or fixtures. You could violate your own mortgage if you waive your interest in these items.

Landlord’s Notice Obligations

Landlords should only agree to use “reasonable efforts” to notify lender of a default which may result in a lease termination. Additionally, your failure to give notice should not void the default, prevent your ability to terminate the lease, or subject you to damages.

Lender’s Right of Occupancy

You should set limits on lender’s occupancy rights, providing that activities are only allowed at reasonable times and notice, and with your representative present. The lender should also agree to pay rent if the tenant fails to do so, obtain adequate liability insurance, covenant to repair any damage to the premises as a result of removing the collateral, and indemnify you from any liability or expenses resulting from its access and removal of collateral. Include language that lender’s failure to remove property by a certain date is considered abandonment, at which point you may remove such property from the premises. In regards to auctions, you may want to prohibit lender from conducting a collateral sale onsite or, if you are inclined to allow a sale, lender must obtain your prior consent and the sale should be subject to your terms. Lastly, lender should agree not to interfere with your efforts to lease the premises to a replacement tenant.

No Further Obligation Of Landlord

The Lien Waiver/Subordination must confirm that all of your obligations terminate upon the earlier of (1) tenant’s satisfaction of its loan; or (2) the end of lender’s occupancy period, in which any remaining collateral will be deemed abandoned.

Attorneys’ Fees

Finally, because you are negotiating and executing the Lien Waiver/Subordination as an accommodation, it is reasonable for you to require your tenant be a party to the agreement and compensate you for reasonable attorney’s fees incurred in negotiating the Lien Waiver/Subordination.

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