COMMERCIAL REAL ESTATE LEASE

A commercial lease is a legally binding agreement made between a landlord and a business tenant. While agreements may be negotiated by reps on the landlord or tenant side (or both), ultimately, it is the owner/landlord who signs as the lessee, and the tenant who signs as the lessor. 

A lease agreement essentially grants a tenant a specific set of rights related to a building, much aside from just being able to occupy space in that building. The biggest determinant of those rights will usually be the type of lease being agreed upon by the tenant and landlord.

A commercial lease grants you tenants’ rights to a commercial property. It’s a legally binding agreement made between a landlord (often the owner of the property) and a business tenant that outlines any terms and conditions you both must follow. Commercial real estate brokers may also negotiate the terms of the lease on behalf of a property owner. Within the lease, the “LESSEE” is the landlord, while the “LESSOR” is the tenant.

For property owners and businesses, the benefits of different lease types can actually vary quite a bit, depending on the business type, location, and intentions of the owner. A good landlord/tenant match in commercial real estate requires a lease that benefits both sides. Landlords need income from rent and they have to control costs to assure a profit. Tenants want to peg their rental costs as closely as possible to manage their own profits and losses. 

While agreements may be negotiated by representatives on the landlord or tenant’s behalf (or both), ultimately, it is the owner/landlord who signs as the lessee, and the tenant who signs as the lessor. A lease agreement essentially grants a tenant a specific set of rights related to a building, much aside from just being able to occupy space in that building. The biggest determinant of those rights will usually be the type of lease being agreed upon by the tenant and landlord.

TYPES OF COMMERCIAL REAL ESTATE LEASES

There are three categories of leases when it comes to commercial real estate: Gross Lease (also known as Full-Service Lease), Net Lease, and Modified Gross Lease. The main similarity among these leases is that they all provide a base rent with variations around who pays for which operational expense.

• Gross Lease / Full Service Lease

In a gross lease, the tenant’s rent covers all property operating expenses. These expenses can include, but aren’t limited to, property taxes, utilities, maintenance, etc. The landlord pays these expenses using the tenant’s rent to offset the costs. As a result, the base rent is typically relatively high but is the only cost to the tenant.

Tenants tend to prefer this type of lease because they don’t have to get involved in the day-to-day operations of the building; the rent is fixed, even if the expenses aren’t. For example: during the summer, rent will remain the same even though air-conditioning use increases electricity costs. This lease is typical for industrial, retail, and office freestanding properties.

Many landlords try to include some variable cost flexibility in the lease by adding “escalation clauses” that account for an increase in insurance or taxes. They can also include language that allows them to temporarily increase your rent based on variable costs. Using the same air-conditioning example, you would receive an increase in your next month’s rent or a bill to cover the cost of use from the previous month.

• Net Lease

The net lease is a highly adjustable commercial real estate lease. The base rent for a net lease is lower than a gross lease, but the tenant also pays fixed operating expenses such as property taxes, insurance, and common area maintenance (CAM) items. There are four types of net leases and they are;

1. Single Net Lease: In a single net lease, tenants pay a set rent and a piece of the property tax (which would be negotiated with the landlord). The landlord then pays building expenses, while the tenant pays utilities and other services directly.
2. Double Net Lease: A double net lease is similar to a single net lease, except the tenant also pays a piece of the property insurance along with the property tax. The landlord takes over paying for the maintenance of the common area, but the tenant is still responsible for his or her own utilities and garbage services.
3. Triple Net Lease: The triple net lease encompasses property taxes, insurance, and common area maintenance, with the tenant paying for some or all of the cost of these three things on top of their base rent. It is one of the most common lease types. This lease structure is definitely favorable to landlords, it gives tenants the ability to review the landlord’s operating expenses, and all savings go directly back to the tenant.
4. Absolute Triple Net Lease: This is the triple net lease magnified. The tenant takes on all costs enabling them to have sole responsibility for the building. It might just be better to purchase a freestanding building outright. The benefit of this lease is that as the tenant you can virtually own a building without buying it; however, if there is a catastrophe that destroys the property you are on your own. This is probably the most uncommon commercial real estate lease.

• Modified Gross Lease / Modified Net Lease

The third major type of commercial real estate lease is the modified gross lease (or modified net lease) and it offers a happy middle ground for both tenants and landlords. The modified gross allows a broader range of negotiations when it comes to operating expenses. The base rent will then be subjected to the terms agreed upon by both parties like the gross lease. The differentiating factor is that the lease rate remains fixed even if costs increase or decrease.

What is a Commercial Lease Agreement?

A Commercial Lease Agreement outlines the landlord’s and tenant’s rights and obligations when the landlord rents out commercial property to a tenant. Either party can be an individual or company. A tenant may also be referred to as a renter or lessee. The purpose of Commercial Lease Agreements is to establish lease terms so parties are bound to them. It also gives the tenant the right to use the rental property for business purposes during the term of the lease in exchange for payment to the landlord.

It is common for landlords and tenants to have disputes, such as disagreeing about who is responsible for repair costs. Without a contract, it is difficult to prove the agreed-upon terms of the tenancy. Having a lease agreement can be extremely helpful if a landlord has to file a legal claim to evict their commercial tenant.

What should be included in a Commercial Lease Agreement?

A Commercial Lease Agreement should include information such as:

• The property’s details, such as the address and legal description of the commercial rental space.
• The permitted use of the rental property and any restrictions placed upon the landlord, such as not leasing to direct competitors in the same building.
• The personal information of the landlord and tenant, such as names and contact information.
• The lease terms, such as the lease type, length, and start and end date.
• Whether or not the tenant can assign or sublease the property.
• The rent details, including the amount, payment frequency, and whether the tenant’s lease will be gross net or triple net.
• The responsibility for utilities and insurance payments, such as who is obligated to pay for which expenses.
• Whether the landlord will charge a security deposit and whether they can increase rent.
• Whether the landlord has to make improvements to the property, or whether the tenant can renovate or make improvements to the property.

CONCLUSION

A commercial real estate lease is a long-term rental agreement between the landlord of commercial space and a business. Whatever the case may be, and whichever lease type a commercial tenant is currently locked into, it can be extremely helpful to understand everything about the commercial leasing process and those involved. Doing research on where you want to lease space, finding the right broker to assist you, and negotiating the best terms will go a long way to helping you get the best possible lease for your property.

 

As informed investors we should understand the risks associated with real estate investing and that there is no guarantee. Please do your due diligence.