What is a Gas Station Lease?
Gas station lease agreements are written contracts that allow for the renting of land and/or facilities for the purpose of operating a gas station. They may take the form of long term leases, day lease agreements for unloading tank trucks at bulk plants, or anywhere in between. These agreements serve a very important purpose , as they outline the rules and responsibilities of the gas station tenant and landlord. This ensures that the parties are working according to the same expectations, and that each knows what steps to take if there is a breach. A well crafted gas station lease agreement will protect both parties, and provide for smooth operation of the gas station.
Common Terms in a Gas Station Lease Agreement
The key elements that go into a gas station lease are relatively generic, as with any commercial property lease. The lease should set out clearly the term of the lease, the rental payments, and whether those payments will increase over time. The lease will also contain a section on maintenance of the premises, including the tank and environmental issues. The lease will almost certainly impose maintenance obligations upon the Tenant in regard to the fuel dispensing system, including protecting it from leakages. Additionally, there will be lease provisions over the operational aspects of the business at hand, including hours of operations, servicing and sales requirements. Issues regarding signage will also be addressed, both through lease provisions and possibly an exhibit attached to the lease. Other important areas include the scope of the real estate included in the lease, including parking, and the remedies available to the landlord upon a default by the Tenant.
Tenants Need to Be Aware of the Following Issues
The location of the property can have a significant impact on the cost of operation. A location with limited overhead visual exposure or heavy traffic congestion, can lead to reduced revenues. Leasing a property with a tenant right of first refusal, will restrict the tenant’s right to expand to another location within the immediate area. Leasing a property located next to an existing gas station, with limited room for expansion, can be beneficial.
Compliance with environmental regulations is a significant issue tenants must monitor. Environmental regulations are stringent and costly. Tenants should be aware of federal, state, and local environmental laws including The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA). Contractors must be EPA-certified, and states will have specific laws governing the disposal of hazardous wastes and clean-up protocols. Local regulation can also include spill prevention control and countermeasures, and aboveground storage tank guidelines. If a tenant leases a property that is contaminated—regardless of when the contamination occurred—they will be held liable. Cleanup costs under CERCLA will result in liability for any gas station property that has a petroleum product release. If they are the property owner, they will be responsible for all cleanup including remedial action. If they are not the owner, but the release was caused by them, then they will hold liability as an operator. Liability extends to parties that have not even handled the contaminated material, such as current owners, past owners, contractors, and workers. Due diligence is critical to limit liability for existing contamination prior to signing a lease, but business interruption insurance will not cover existing contamination.
Gas station operators must analyze their creditworthiness. The cost of operation includes significant expenditures for maintenance and fuel purchases. Gasoline prices and inventory levels can fluctuate significantly, presenting unexpected financial issues. Industry volatility can affect fuel prices and demand, affecting profitability, while market fluctuations can affect purchasing prices. Operators must have strong revenue and inventory management to minimize these issues, but if financial troubles arise, financing options or personal assets might be the best option.
Contract negotiation comes down to several clauses. The renewal clause will dictate if the tenant must vacate or not at the end of their term. Rent to Gross Revenue Ratio will establish rent as a percentage of gross revenues, while Percentage Rent Clause will establish an increment above minimum rent. The Escalation Clause will adjust rent annually. The Subleasing Clause will establish if the tenant can sublease the property. The Termination Clause will establish the conditions under which either party can terminate the agreement. Finally, the Indemnification Clause will assign liability for legal claims, including contamination.
What Landlords Need to Look Out For When Drafting Gas Station Leases
The inclusion of a security deposit in the lease is a good way for fuel companies and gasoline station owners to align their interests. The landlord will generally want a security deposit large enough to cover unpaid rent and/or damage or removal from a site of any tanks and/or other infrastructure that may otherwise become the landlord’s property. If the site is discontinued and there is a potential for damage to the site by leaking underground tanks, the size of the deposit can be negotiated based on that risk. Fuel companies are typically more than willing to post a security deposit. There can be some type of agreement to reduce the amount of the security deposit if the company proves that it has the money to complete its cleanup obligations, and otherwise it can be used in conjunction with obtaining additional environmental indemnification obligations and a contractual right to reimbursement for certain costs. As a result, the security deposit can serve multiple purposes. Where a bank guarantee is provided, the bank should be on notice of the maximum liability and the agreement should have provisions regarding the release of the liability.
A gasoline station site is usually a small site, and many of the improvements are kept as small as feasible and in accordance with state environmental regulations. In order to provide sufficient flexibility on site development, fuel companies will usually want to include one or more provisions permitting alterations to the site in order to change site design. Fuel companies want the ability to alter the site as necessary to comply with site-wide, state or federal regulations. There are two typical ways to allow for alterations in the lease. The first option is to allow the fuel company to make modifications to the site without having to obtain prior approval from the landlord, so long as the modifications will not have a material impact on the value of the property or the rental stream. However, fuel companies often negotiate a clause that allows it to proceed with changes required in a regulatory context. The second option is to require the fuel company to receive prior approval for all modifications it intends to make to a site. In addition, the landlord will want a right to inspect the site when alterations occur in order to identify any potential damage to its property or the underlying soil. To that end, a sample clause requiring notice of and permission for alteration is as follows:
Tenant shall not make any alterations or additions to the Premises without Landlord’s prior written consent, which consent shall not be unreasonably withheld, conditioned or delayed; provided that Tenant shall furnish to Landlord evidence of a permit from the applicable authority covering any alterations to the Premises in connection with the installation or operation of any machinery, equipment or storage tank. Notwithstanding the foregoing Tenant shall not be required to obtain Landlord’s approval prior to making a Permitted Alteration. For purposes of this Lease "Permitted Alteration" shall mean: (a) any work which, as determined by Landlord, does not materially alter the exterior, structural or mechanical character of the Premises or (b) any alterations which have been approved by Landlord in accordance with the preceding sentence.
An important lease provision will often include a definition of condemnation and whether the condemnation of half of the property gives the tenant a right to terminate. Some of the more detailed provisions will define full and partial condemnations and will include a right for the tenant to choose early termination on the partial taking. Also, any payment for the taking of the land itself should be negotiated as a reduction in rent rather than as a division of proceeds. A sample clause that landlords often negotiate is as follows:
In the event the Premises is taken or is to be taken under conveyance to or in condemnation or by the exercise of the power of eminent domain (any such actions a "Taking"), either in whole or in part, whether temporary or permanent (such as by virtue of the taking of right-of-way, street, sewer, connection or other public use), then the following shall apply:
(a) If 10% or more of the Premises is Taken for any reason, Landlord may terminate this Lease as of the date possession is taken by the condemning authorities. If the Premises are Taken as hereinafter described but this Lease is not terminated as above provided, then the Term shall remain in full force and effect subject to Section [RELOCATION] hereof.
(b) In the event of a partial Taking, and this Lease is not or cannot be terminated by Landlord as above provided, the Base Rent and Operating Expenses payable by Tenant under this Lease shall be reduced in an amount equal to the ratio of the area Taken to the entire area of the Premises (before any Taking) to the extent that such a partial Taking makes the Premises inadequate for its intended purpose as a competitive gasoline service station. If, by reason of any Taking in which this Lease is not so terminated, the Premises are made inadequate for such purpose, Tenant agrees to restore the Premises as soon as practicable after such partial Taking in order to make the same adequate for such purpose.
Common Roadblocks in Gas Station Leasing
Gas station leasing presents a unique set of challenges to tenants and landlords. Some of those are common to all leases, but there are special issues that need to be considered. The high volume of transactions and the sometimes very high rents charged to gas station tenants, means that even one data point can have an enormous impact on the overall pro forma and attractiveness of a deal from an economic perspective.
In addition to the ordinary lease challenges, issues such as downtime and the impact on the transaction as a whole, often loom large. For example, how much downtime do you build into the pro forma when you are dealing with a major refueling of a very large double wall tank system? Have you incentives built in, or perhaps a requirement that the landlord complete the refueling, but allow the tenant to choose the vendor to perform the work? Has the pro forma been prepared so that it assumes no change in the economic environment as a result of volatile gas prices, so the tenant will be protected against increases? Do you have a chance to lock in a supply agreement that will guarantee a fixed profit spread going forward?
There are environmental considerations as well, in addition to the required remediation from time to time that should be addressed to avoid needless impact on your pro forma . Can the tenant do more than just sell gas under the lease – does the tenant have the right to sell convenience store items if the operation is funded sufficiently? Are there restrictions on other uses that would be permitted at the property?
So what are the typical conditions for gas station leases? Generally a long term, perhaps a little longer than you are used to, assuming the local market can accommodate it. The economics are driven by rent factors above the line, with limited additional property taxes or operating expense incorporated in the rent payable by the tenant. Often the tenant, particularly on a new build lease, will open its own bank account to pay the landlord property taxes and some utilities directly. It is common to see a challenging negotiating environment in these cases.
How to Negotiate a Gas Station Lease to Your Advantage
Ample negotiation between landlord and prospective tenant is essential prior to agreeing on the terms of a gas station lease. Unless there are proposed improvements or substantial changes to the property (such as remediation of contaminated soil due to releases or spills from current operations), the landlord should be careful to limit/promote any improvements by the tenant. The following are some strategies to consider that can be beneficial to both landlord and tenant.
Initial Term/Extensions
The initial term of a gas station lease should be 20-25 years. A tenant may wish to have an option to extend this initial term for one or two additional five year periods by providing the landlord with advance written notice six months prior to the expiration of the initial term, but not earlier than six months prior to the expiration of the then-current extension term. The only condition which the landlord may require in order for any extension to occur is 1) that the tenant be in compliance with all lease terms; and 2) that the tenant not be in default under the lease. However, the landlord may wish to add additional conditions to his or her benefit such as requiring tenant to: demonstrate that it has all licenses and permits required to conduct its business; not be operating a different convenience store or gas retailer(s) or distributorship(s) within a specific geographical area; and/or that tenant has made a specified minimum amount of capital improvements to the store and adjoining property during then-existing term.
Additional Flexibility for Landlord
Sometimes a landlord may wish to retain more flexibility than a typical lease permits and to reduce the usefulness of the property as a gas station by limiting the hours of operation of the gas station, restricting the type of fuel to be sold or imposing other restrictions to limit the number of commercial customers. Standard lease negotiation techniques can be relied on to negotiate for this flexibility. In addition, the successful landlord will wish to negotiate a provision allowing it to terminate (and only it) the lease for any reason upon at least 30 days’ prior written notice. The lease should also provide the landlord with a right of first refusal to purchase the subject property and the right to relocate the convenience store to an adjacent location, if the landlord believes that moving the convenience store to a higher visibility location on the property will be beneficial to its ability to lease the property.
Additional Flexibility for Tenant
Tenant may wish to negotiate for even more benefits in exchange for a longer lease. These may include a larger security deposit and monetary allowance for relocating the convenience store to the new location. For example, tenant may seek to have a right of first refusal to purchase the subject property and a right of first offer to lease other locations owned by the landlord at just below fair market rent, without competition.
Legal and Environmental Issues When It Comes to Leasing
Gas station lease agreements are inherently impacted by various legal and environmental rules and regulations. Zoning laws, environmental assessments, and other local governing bodies may impose additional duties or obligations on the gas station tenant and landlord. It is critical to have experienced counsel on your side to wade through the various local, state, and federal laws that impact these agreements. There are five notable aspects to consider:
Zoning Laws
Gas stations may conflict with local zoning ordinances if the area is not zoned for such use. These ordinances may prohibit certain businesses from opening based on location, size of the business, and other factors. Several places prohibit gas stations from operating because they may present a public nuisance, create an increased risk of harm to the public, and violate local health and safety standards. Ensuring the property is allowed to operate as a gas station is essential.
Environmental Assessments
Environmental assessments (EAs) are often required for businesses that process hazardous materials, like gas stations. The objectives of an EA include the following:
These assessments may also provide information about the remediation of those hazards. Many states require EAs to be done every two years. Examples of common hazards that must be assessed in an EA for a gas station include:
Permit Requirements
Depending on the area and the property, zoning laws and regional or municipal ordinances may require the business to obtain permits. This may include environmental permits, hazardous material use permits, fire prevention permits, risk management plans, and others. These permits may require a variety of documentation to be submitted with the application and usually must be renewed every few years.
Tenancy and Liabilities
What happens after a new tenant takes over the gas station? Some courts have held that landlords are liable for preexisting contamination when leasing the property to another party. This "holdover liability" can require landlords to report preexisting contamination to the EPA and even makes them potentially responsible parties under the CERCLA Superfund act. This liability can extend to prior owners and subsequent tenants.
Local Laws and Ordinances
Several local laws and ordinances may create additional obligations on the landlord and tenant, including specific requirements for petroleum transfer, sales, and waste disposal. For example, landowners may be responsible for oil spills, gas tank testing, and frame leak inspections. Additional duties may be prescribed to landowners and businesses through other requirements, regulations, and ordinances.
Renewing or Terminating Your Gas Station Lease
Although many leases are evergreen, meaning the initial term is automatically renewed at the end of the term, a party may be able to terminate or refuse to renew the lease agreement altogether by properly complying with the lease renewal provisions.
Usually the renewal language states the lease may be renewed for additional one year periods. The tenant has to give the landlord a certain amount of notice (usually 15 to 30 days) prior to the end of the term of its intent to renew. The notice must state that the tenant is sending the notice for renewal purposes. Sometimes, rental increases are determined (i.e., by the CPI or the appraised value of the property) and the tenant has the right to accept (or reject) such increase (generally within 10 days after receipt of the rent increase notice from the landlord). If the tenant accepts the increase, he follows the process of signing the increase in rent. Failure to sign or other failure to follow the proper processes in the lease could result in property being vacated at the end of the term. Termination of the lease during the term requires the parties to comply with the termination provisions of the lease as well as any laws that are applicable to the particular property (e.g. , Prohibition on Termination of Petroleum Marketing Franchisees (PMI) Act, The Petroleum Marketing Practices Act, etc.). In California, transferees of retail petroleum marketing franchises may be protected by the Petroleum Marketing Act. There are termination provisions typically found in the lease. A party may terminate the lease for continued breach of any material provision of the lease after notice of default to the tenant if the tenant is given a reasonable time period to correct (generally 30 days). Also, the lease may delineate the conditions under which a party may terminate the lease. Typically, in most termination clauses, both parties have the right to terminate for any reason upon a period of notice (usually 30 to 60 days). To terminate a lease, the landlord generally delivers a written notice to the tenant via hand delivery, mail or email according to the terms of the lease agreement. The termination generally is effective as of the date stipulated in a written notice sent by the landlord. Upon delivery of notice of termination, the tenant shall discontinue use of the premises and quit and surrender the premises to the landlord.