At some point in the life of most businesses, you will need to rent some space. That means you will have to read a commercial lease. Commercial leasing is different than renting an apartment or a house. The relationship between a landlord and a commercial tenant are quite different than its residential counterpart. Today, let’s talk about commercial leases. This email should be used as a primer before you begin looking for commercial space and as a guide to help you review the commercial lease that has been placed before you.
Commercial leases are quite long. The reason is: it is actually two contracts in one. A commercial lease covers two topics:
- The grant of interest in real property (what property you can use)
- The agreement between the landlord and the tenant
The relationship between landlord and commercial tenant is quite complicated because it relates to how the property can be used and who is responsible for what in the relationship. Because of this, it is important to review any commercial lease that has been provided to you. Of course, it is important to thoroughly review every contract given to you, but the commercial lease is one of the most important contracts you will sign for your business. It can also be one of the most expensive.
Whether you are looking for your first office space or you are expanding your current operation, this guide will help you better understand commercial leases and how they impact your business.
One important factors regarding a commercial lease: It is always negotiable!
In a commercial lease, landlords are trying to push off as many expenses and as much liability of the property to the landlord as possible. It is important for any tenant to understand not only the rent being charged, but any other expenses being charged to the tenant.
Property Being Leased
In a commercial lease, there are two different parts of the property that is being leased:
- The Demised Premise
- Common Areas
Of course, if you are renting an entire building, the Demised Premise should be everything. The Leased Premises or Demised Property provisions are some of the most important in your lease. This provision defines what is being leased in the agreement between landlord and tenant.
One of the most important issues in a commercial lease is the Rent and how it is charged. In a commercial lease, the Rent is a total number for the life of the lease that is paid over time. So, you cannot think of a lease as $5,000.00 per month for five years, but you must think of the lease as a $300,000 agreement that you will pay over five years. If you breach the lease, it will trigger the “Accelerated Rent Clause”. So let’s talk about rent and the various options.
As I have mentioned before, a commercial lease is much different than a residential lease. One of the ways is the various types of rent that exist in a commercial lease. The different types of rent that can be charged are:
Gross or Full Service Rent
In a gross lease, the rent is all-inclusive. The landlord pays all or most expenses associated with the property, including taxes, insurance, and maintenance out of the rent received from tenants.
When negotiating a gross lease, you should ask not only what services are provided nit also how often those services are offered. You should also ask if there are any overage charges or specific use allowances for utilities.
A benefit of this type of lease is that it is easy for the tenant to forecast expenses without worrying about an unexpected charge from the landlord. The landlord assumes all responsibility for the building, while you concentrate on growing your business.
Net Commercial Lease
In a net lease, the landlord charges a lower base rent for the commercial space, plus some or all of the “usual costs,” which are expenses associated with operations, maintenance, and use that the landlord pays. These can include many different items, such as real estate taxes; property insurance; and common area maintenance items (CAM). CAM charges can include janitorial services, property management fees, sewer, water, trash collection, landscaping, parking lots, fire sprinklers, and any commonly shared area or service.
There are several types of net leases:
Single Net Commercial Lease
In this type of commercial lease, the tenant pays base rent plus a pro-rata share of the building’s property tax (meaning a portion of the total bill based on the proportion of total building space leased by the tenant). The landlord covers all other building expenses. The tenant is typically required to cover the utilities and janitorial services.
Double Net Commercial Lease
In this type of commercial lease, the tenant is responsible for the base rent plus a pro-rata share of property taxes and property insurance. The landlord covers expenses for structural repairs and common area maintenance. The tenant once again is responsible for their own janitorial and utility expenses.
Triple Net Commercial Lease
This is the most popular type of net lease for commercial freestanding buildings and retail space. It is known as the net net net lease, or NNN lease, where the tenant pays all or part of the three “nets”–property taxes, insurance, and CAM charges. Of course, that is on top of a base monthly rent. Common area utilities and operating expenses are usually lumped in as a part of the CAM charges. In addition to these, tenants may be required to pay for other costs such as: janitorial services, utilities, and their own insurance and taxes.
To determine the CAM charges, Landlords typically estimate expenses and charge tenants a portion of the estimated expenses based on their proportionate, or pro-rata share. In a triple net lease, a tenant who leases 1,000 square feet of a 10,000 square foot building would be expected to pay 10% of the building’s taxes, insurance, and CAM charges.
Negotiating Tip: Because Triple Net Leases are more landlord-friendly, you should try to negotiate caps on the amounts your fees can be raised each year or on when fee increases can happen.
As the economy changes and the landscape of commercial leasing is different, a new type of lease has been developed. The modified gross lease (sometimes called the modified net lease) is similar to a gross lease because the rent is paid in a negotiated sum. The rent includes some or all of the “nets” discussed above (i.e., property taxes, insurance, and CAM charges). Utilities and janitorial services are normally covered by the tenant. The negotiation strategy of this modified commercial lease revolves around which nets are included in the rent.
What Does this Mean for Your Business?
Many small business owners are afraid to negotiate with the “big landlords”. Too often, leases are signed without negotiation because you want a certain space. This is not always the case. The key to negotiating a commercial lease is to understand what you bring and what they bring. Some spaces are prime. Everyone wants them. In that case, you don’t have a lot of leverage. In some cases, you bring a lot to a particular area and can lean on that leverage.
Whatever the case, make sure you understand the big picture in the negotiation. Go for what matters and leave alone what doesn’t.