10 Key Things You Need to Know
Before You Lease Commercial Real Estate
1. Lease Types
Commercial leases generally fall into 3 categories based on how the building’s operating expenses are passed on to tenants:
Gross or (FS) Full-Service lease.
You pay a flat monthly rate from which the landlord pays all operating expenses, including utilities, property taxes and maintenance. This is a simple and convenient option for tenants. Just make sure you understand the extent of expenses included with the lease. For instance, are cleaning services provided? Is heating and air conditioning available 24/7? Is there a limit on electricity use, and if so, how will you be charged for excess? All such terms should be spelled out in the lease, so there are no surprises down the road.
(NNN) Net lease.
In a net lease, taxes, insurance and building maintenance are shared between the landlord and the tenants in one of three ways. With a single net lease(N), you will pay monthly rent as well as the property taxes, while the landlord pays the rest. With a double net lease(NN), you will pay for insurance along with the taxes and rent. With a triple net lease (NNN), you will pay for taxes, insurance and building maintenance costs in addition to the base rent. If you share the building with other tenants, the expenses you assume are pro-rated based on your share of the building’s square footage. Your lease should specific what percentage of the building you occupy, and that percentage will determine what amount of the additional expenses will be passed on to you by the landlord. Pay particular attention to additional expenses, and operating expenses, and capital improvements that can be passed on. Ask about projects that the landlord has underway which he collects reserves for like new roofs, paint jobs, and parking lot resurfacing. Yes you benefit from these improvements, but you want to make sure you are only paying your fair share.
Modified gross lease.
This type of lease is a cross between a net lease and a gross lease. Usually, you will have a gross lease but will be responsible for certain agreed-upon expenses, such as cleaning services, electricity or minor repairs. The landlord will assume payment for the rest.
2. Know What You Are Agreeing to Pay For
Before signing a lease, be sure you understand the type of lease, who will pay for what, and the potential extent of the costs you agree to assume. Ask to see examples of the expenses you will be expected to pay and negotiate caps to minimize unexpected expenditures.
3. Square Footage
Most commercial leases are quoted on a Rentable Square Foot (RSF) basis. This includes the (USF) or Usable Square Footage which is the square footage of the premises you would occupy, plus a pro rata share of the building’s common areas (if shared with other tenants) such as lobbies, staircases, corridors and restrooms. In an office lease, this is an important distinction as there will be a difference between the square footage you actually have use of and the square footage for which you will be charged monthly.
In evaluating different properties, measure the USF for yourself or have your broker assist you by asking the landlord to provide a floorplan with dimensions. This will allow you to accurately determine and compare the size and costs of the premises your business will potentially occupy. Buildings with a high percentage of common areas typically are a more costly option.
4. Lease Term
Most landlords prefer long-term leases of five to ten years, to keep vacancies to a minimum. You may get the best deal with a long-term lease, but it can become a costly liability if you go out of business or outgrow the space before the term is up and you are still responsible for the rent. One-two year leases with an option to renew offers the flexibility your small businesses may need—until you’re confident of its success and stability. However, you will likely pay more in rent and be subject to larger rent increases in a landlord’s market. Try to work out a cap on any rent increases, whether annually or upon the renewal of your lease, in order to keep the space affordable.
5. Early Termination Clauses
Landlord’s don’t like these, but if you think there is a strong potential that you might need to terminate your lease for any reason, consider asking to include provisions that allow you to do so as painlessly as possible, including:
- The right to transfer or “assign” your lease if you sell your business. This allows your business’s new owner to stay in the same space.
- The ability to sublet all or a portion of your space if you are unable to afford the rent or need to move to a larger space.
- The right to sublease to other entities you own and control without landlord permission
Be aware, that early termination clauses typically come with financial penalties sometimes up to six months rent, but that flexibility might be worth it if you need to move on before the lease term is up and you are on the hook for the full remaining term.
6. Your Neighbors
Nearby tenants especially in retail can have a significant impact on your business location. If your business depends on a nearby business to bring foot traffic, a co-tenancy clause will allow you to break the lease if that tenant leaves and isn’t replaced within a certain amount of time.
7. Exclusive Use Agreements
If you are worried that there may be competing tenants nearby in buildings that the landlord owns, you can ask for an exclusive use clause. It is not uncommon for national tenants like Starbucks, to negotiate that only they can sell coffee and food related items in certain retail areas. Sometimes exclusive use clauses are written that the tenant with the exclusion has a right to agree to a certain tenants new use. This is something you would want to discuss with your broker when you first start looking for space.
8. Tenant Improvements
If you need to alter the space to suit the needs of your business, negotiate inclusion of “build-out” provisions in the lease that specify:
- Specifically what tenant improvements/alterations will be made
- Which party will pay for the improvements (in longer-term leases, the landlord may pick up all or some of the cost and expect the Tenant to repay the cost over the term of the lease amortized at a reasonable rate of interest)
- Who is allowed to complete the work. Typically you have to hire licensed professional contractors and trades people to do the work, and pull permits and other necessary documents to comply with local building codes and requirements
- Who will own the improvements (typically, the landlord does)
- If the tenant (you) will need to return the space to its original condition when the lease expires
Work Letters which are typically added as Addendums to the lease will outline specifically tenant improvement work is to be completed and by which party. It is critically important especially in newly construction projects, that you understand what the build out allowance(if any) is, and how much additional money will be required to get the space move in ready. System Development charges, permits, and change of use fees can often be unpleasant expensive surprises, so working with your contractor, and spending the time upfront to understand the requirements to getting your certificate of occupancy is critical.
9. Option to Renew
If you think that you will want to occupy the space longer than the initial lease term you should consider negotiating an option to renew clause which will outline an additional term you are entitled to, when you need to let the landlord know you intend to stay, and what the rent for the renewal period is based on. Some landlords don’t like options to renew, because it lowers flexibility, but for a landlord who intends to hold the building long term, options allow them an easy way for the parties to extend the lease, and except for rent and term, things typically stay the same.
10. Professional Assistance
A commercial real estate broker can be invaluable in helping you find commercial property and working through the complexities of a lease by helping you with preparing lease proposals with the terms and conditions specifically tailored to your company’s needs. Commercial brokers have the contacts, the market knowledge and the expertise to save you money, and time so you can focus on the details that matter most to you. In most cases the landlord pays the broker’s commissions based on the value of the lease, once the lease is fully executed, so utilizing a professional who knows the market, has knowledge about recent transactions, and can uncover the best locations is really in your best interest.
A commercial lease is a legally binding contract, so it is critical that you fully understand and carefully evaluate the lease document so you’ll be prepared to negotiate a lease agreement that meets your space and business needs. Our advice is hire a real estate attorney who is well versed in commercial leases and local lease practices to guide and advise you through the process to get a lease document best suited to your specific business.