Commercial Leasing Changes You NEED to Know Starting January 1, 2025

In 2019, the California State Legislature enacted the Tenant Protection Act, aimed at protecting long-term residential tenants by limiting rent increases and restricting evictions. 

To date, statewide tenant protections have been limited to residential tenancies. This will change on January 1, 2025, with SB 1103’s creation of three new protections for “qualifying commercial tenants.” Landlords and tenants alike should take notice of SB 1103’s implications for the commercial real estate market and the trend toward greater tenant protections in commercial real estate.  

Applies to “Qualified Commercial Tenants” Only

SB 1103 makes significant changes but for now, they apply only to “qualifying commercial tenants.” A qualified commercial tenant is 1) a tenant that is a microenterprise (as defined in Business and Professions Code Section 18000(a)—typically fewer than 5 employees and limited capital); 2) a restaurant with fewer than 10 employees; or 3) a nonprofit organization with fewer than 20 employees. 

Affirmative Notice Requirement

Even if a tenant meets this definition, to benefit from the protections created by SB 1103, it must affirmatively provide written notice to the landlord of its “qualified commercial tenant” status before the execution of the lease (if the tenancy is longer than 30 days) and annually thereafter. With proper notice, a “qualified commercial tenant” is entitled to additional landlord processes for documenting and charging building operating fees and costs, negotiating language translation, and additional notice for rent increases and terminations.

Building Operating Expenses

Commercial landlords are recovering building operating expenses to achieve profitability, whether expressly stated in a triple net (“NNN”) lease or baked into the rent in a gross lease. SB 1103 uniquely impacts this market calculation by creating Civil Code Section 1950.9, which provides, in relevant part, that a commercial landlord cannot impose building operating costs on a qualified commercial tenant unless:  

1. The building operating costs are allocated proportionately per tenant, by square footage, or another method as substantiated through supporting documentation provided by the landlord.
2. The building operating costs have been incurred within the previous 18 months, or are reasonably expected to be incurred within the next 12 months based on reasonable estimates.
3. Before execution of the lease, the landlord provides the prospective qualified commercial tenant with a notice stating that the tenant may inspect supporting documentation of building operating costs upon written request.
4. Within 30 days of a written request, the landlord provides the qualified commercial tenant with supporting documentation of the previously incurred or reasonably expected building operating costs.
5. The costs do not include expenses paid by a tenant directly to a third party.
6. The costs do not include expenses for which a third party, tenant, or insurance reimbursed the landlord.

A landlord seeking to charge a “qualified commercial tenant” for building operating costs must affirmatively provide “supporting documentation” and may not alter the method or formula used to allocate building operating costs unless the “qualified commercial tenant” is provided with written notice of the change and a basis for the changed allocation. The new Civil Code Section 1950.9 also creates a civil cause of action for tenants against landlords in violation of its provisions.

To say these changes are significant is an understatement. The terms now imposed by Section 1950.9 are typically heavily negotiated between landlords and tenants as it relates to what “operating expenses” will be charged (or excluded) under the lease and how those charges will be allocated. More striking is the automatic right to audit built into the structure of the statute. Institutional landlords are unlikely to automatically grant tenants audit rights, typically reserving them as an issue for negotiation (usually upon a savvy tenant’s request). Moreover, because the term “supporting documents” is undefined, it is unclear what documents landlords should retain. The lack of clarity may result in landlords holding unnecessary records or worse, running afoul of the rule by unwittingly purging necessary ones.  

Critics of SB 1103 note the administrative burden placed on landlords under this section could chill the commercial real estate market, resulting in increased rents, fewer spaces, and overall, end up actually harming the small businesses and nonprofits it is designed to protect.  

Additional Notice for Rent Increases and Termination

Qualified commercial tenants will now be entitled to at least 90 days’ notice of any rent increase exceeding 10% of the rent charged during the previous 12 months and at least 30 days’ notice for similar rent increases less than 10%. If a “qualified commercial tenant” has occupied a commercial rental property for more than one year, landlords will now also be required to provide such tenants with at least 60 days’ notice of termination (and 30 days’ notice for tenancies less than one year).  

This is also a remarkable change where commercial tenancies have historically been governed by the contractual lease agreement between the parties on matters of notice and termination. While not expressly stated in the bill’s language, it is possible, that these timeframes (where applicable) will override any conflicting contract language.  

Translation Requirements 

Certain commercial transactions already include a translation requirement (mortgages, for example). SB 1103 extends this concept to commercial lease agreements for “qualified commercial tenants.” Where an applicable commercial tenancy agreement is primarily negotiated in a different language, both landlord and tenant must be provided a copy of the tenancy agreement with all terms translated into that language.  

Failure of a landlord to provide a translated copy of the tenancy agreement allows a “qualified commercial tenant” the opportunity to rescind the agreement. Notably, landlords do not enjoy the same right to rescind a tenant’s noncompliance with the translation requirement. The statutory language may also prove problematic because there is no time limit for a tenant to rescind a lease for a landlord’s failure to comply with the translation requirements–whether at the time of execution or five years down the road when the tenant is in default. 

What does it all mean for the commercial leasing market in California?

Like its residential counterpart under the Tenant Protection Act, many of the commercial tenant protections enacted under SB 1103 are expressly not “waivable” – meaning language purporting to contract around or modify the protections of SB 1103 will be considered void. 

Critics of SB 1103 note the bill’s failure to appreciate the difference between commercial and residential real estate markets most glaringly in the increased financial/administrative burden to achieve (and maintain) compliance with the changes over the course of a long-term tenancy (with commercial tenancies more likely to range between three-10 years). Supporters of the bill’s protections note there are no limitations on the amount of a commercial lease increase and appreciate the notice requirements and the transparency in operating costs for smaller and nonprofit tenants.

It is clear tenancy protections impacting the residential and commercial markets in California are here to stay. While the true impact of these first-in-the-country commercial protections on California’s commercial real estate market remains to be seen, the implications of legislative mandates to a private, fully negotiated commercial contract are notable and require knowledge and action. There will be a period of adjustment but as with all regulations and mandates, the market will adapt to these changes. Should you have any questions regarding when these changes apply and how to implement them, reach out to your BBK attorney or Jessica Lomakin.

Disclaimer: BBK Legal Alerts are not intended as legal advice. Additional facts, facts specific to your situation, or future developments may affect subjects contained herein. Seek the advice of an attorney before acting or relying upon any information herein.