Expansion and Alteration Rights After You Sell

As an owner, you could add a dock door, pour a new equipment pad, convert storage into exam rooms or put up an addition whenever the business needed it, subject only to permits and your lender. After a sale-leaseback, the building is someone else's asset. The investor has a legitimate interest in what is done to it, and the lease is the only document that says what you may do without asking.

Standard investor lease forms tend to start from a cautious position: no alterations without the landlord's prior written consent, with consent in the landlord's discretion. For a company that reconfigures its space regularly, that default is unworkable. The good news is that this is one of the more negotiable parts of a leaseback, because a tenant investing in the building generally makes it more valuable, and investors know it.

The practical approach is to divide work into categories and attach a different rule to each, so routine changes never reach the landlord's desk.

• No consent, no notice: cosmetic work, and installation, relocation or removal of your machinery, racking, trade fixtures and equipment.
• No consent, notice only: non-structural interior alterations that do not affect the roof, structure or building systems, up to a stated cost per project or per year.
• Consent required, not to be unreasonably withheld: structural work, roof penetrations, changes to building systems, and exterior changes. Include a response deadline and a rule that silence after a second notice counts as approval.
• Separately negotiated: additions that increase the building's footprint or floor area.

The dollar threshold in the second tier is a negotiated number. Set it with your operations team by looking at the projects you have actually done in recent years, not by accepting the figure in the first draft.

List planned projects in the lease. If you already know you will add a mezzanine, a clean room or a paint line, have that work approved in concept as an exhibit at signing.

Ownership of improvements matters at three moments: when you finance equipment, when you make changes, and when the lease ends. The lease should state plainly that your machinery, equipment, trade fixtures and other personal property remain yours, may be removed at any time, and may be pledged to your equipment lender. Lenders often ask the landlord to sign a waiver or subordination of any claim to that equipment, so it helps to have the landlord's obligation to sign a reasonable form written into the lease.

For improvements that become part of the building, the question is whether you must remove them at the end of the term. The time to settle that is when the work is approved. Ask for a provision that the landlord must say, at the time it consents, whether removal will be required, and that anything it does not designate may stay. Improvements that were in place when you sold the building should be accepted as they are.

If there is excess land on the site, or the business may outgrow the building within the lease term, raise expansion before you sign. There are several ways to structure it, and they are not mutually exclusive.

• Tenant-funded expansion: you have the right to build an addition at your own cost, subject to plan approval. Simple for the landlord, but you are investing capital in a building you do not own, so the remaining lease term and renewal options need to be long enough to justify it.
• Landlord-funded expansion: the landlord pays for the addition and you pay additional rent based on its cost. This keeps your capital in the business, which is consistent with why many companies do a sale-leaseback in the first place.
• Retained land: you keep the expansion parcel out of the sale, if it can be legally divided, and decide later whether to build, sell or lease it.
• Right to request: the landlord agrees to consider funding an expansion on terms to be agreed. This is the weakest version, since it commits no one to anything.

Investors vary a great deal on this. Some actively want to fund expansions for existing tenants because it adds to an investment they already understand. Others, including many individual buyers, have no capacity or appetite to do it. If expansion is likely, that should influence which buyer you choose, not only what the lease says.

A landlord-funded expansion clause that says only that the parties will agree on terms later gives you very little. The more of the following you fix at signing, the more the right is worth.

• ✓How is the added rent calculated, and on which costs?
• ✓Which costs count: hard construction costs only, or also design, permits, financing and the landlord's oversight fee?
• ✓Who designs, bids and manages construction, and who carries the risk of cost overruns and delay?
• ✓Does the lease term extend when the expansion is delivered, and by how much?
• ✓Does rent on the existing building change, or only the rent on the new area?
• ✓Do the rent escalations on the new area follow the same schedule as the original lease?
• ✓Is the landlord obligated to fund if you meet stated conditions, or may it decline?
• ✓If the landlord declines, may you build it yourself, and what happens to that investment at the end of the term?

An investor will almost always want additional term in exchange for new capital. That is a fair trade if it matches your operating plans, and a reason to model the expanded lease as a whole before agreeing.

Even with broad rights, expect conditions on how work is done: licensed and insured contractors, compliance with codes and permits, lien waivers, and as-built drawings for larger projects. These are reasonable. Push back on conditions that add cost without protecting anyone, such as landlord supervision fees on work you pay for, or a requirement to use the landlord's contractors.

One point that is easy to overlook: the landlord's own lender may have approval rights over major alterations. If the lease promises you a response within a set number of days, ask that the landlord take responsibility for obtaining its lender's approval within the same period.

When we negotiate a leaseback, we ask the people who run the facility what they expect to change over the next several years and build the alteration and expansion language around that list. A lease written around real plans is easier to negotiate than one written around hypotheticals, and it holds up better.