How To Understand Commercial Leasing

By Jennifer Fletcher, 21 Jan 23:32

Leasing, Auto Leasing, Car Leasing, Equipment Leasing, Computer Leasing:

Commercial property is defined as real estate that is zoned for business or commercial use. Leasing - rather than buying commercial real estate - is often a more practical and affordable solution for small businesses than buying a building outright.
This is generally true when:

-your current cash flow does not allow the up-front outlays and down payment required for a purchase,
-you don't want to be responsible for building maintenance, Before becoming famous for his role as Frankenstein's monster, Boris Karloff worked in real estate.
-you want to remain mobile in terms of type or size of business space and/or location,
-your company's credit rating will not support a mortgage,
-you haven't been able to locate property you'd like to purchase,
-declining real estate values make buying a building unwise,
-leasing through inner city incentive programs provides substantial discounts,
-sub-leasing or being part of a business cooperative yields value-added benefits; and/or
a lease can cut your tax bill even more than a purchase.

Types of Leases
Even though you may already work with a commercial real estate broker, you should become familiar with the different kinds of leases available as they can substantially impact whether or not your business will succeed. These vary from property to property and include:

Gross Lease. This is the most common kind of lease in which you as the tenant will pay rent and your landlord taxes care of taxes, insurance and maintenance costs related to the property.

Generally, gross leases contain escalation clauses allowing the amount of your rent to be adjusted (usually each year) to offset your landlord's increased expenses.

Net Lease. A net lease transfers some or all of the expenses a landlord is traditionally responsible for to you as the tenant. With a single net lease, you will pay rent plus taxes related to the portion of property you are leasing. Under a double net lease, you will also pay a proportional part of the building's insurance premium. With a triple net lease, you will pay all of the charges under a double net lease plus maintenance costs.

Fixed Lease. This kind of lease provides for a fixed amount of rent over a fixed rental period (term).

"A verbal contract isn't worth the paper it's written on." - Samuel Goldwnyn (1882-1974)

This kind of lease seems most non-threatening at first glance, since you are not obligating yourself for rent increases in the future (as with a gross lease). However, there is a downside to a fixed lease. If you want to renew the lease when it expires, the landlord may choose to raise your rent substantially (especially if your business appears to be doing well and would suffer from relocating elsewhere). It may be better to opt for a longer term lease with pre-fixed or determinable rent increases so you know what you are getting into in advance.

Step Lease. A step lease provides for pre-set rent increases that go into effect at stated times. This can provide you with peace of mind insofar that you will know in advance what your rental amounts will be for a longer period. However, you should take a careful look at each scheduled increase and determine if they seem reasonable; i.e., in keeping with historic consumer price indexes or local rental increases.

Percentage Lease. This kind of lease allows your landlord to share in your success or bad fortune. A percentage lease provides for a fixed amount of rent, plus an additional amount that is set as a percentage of your gross receipts or sales.

The following defines the terminology of provisions that will affect your commercial lease.
Lease Term. This identifies the amount of time the lease will be in effect. If you think you may want to stay at this same business location beyond the initial term, you should negotiate an inclusion in your lease agreement that entitles you to renew the lease for a specified period and rent.

Rental Rate. This defines what your rent is and when it must be paid. Most leases also include late payment provisions that impose additional charges if you fail to pay the rent when it's due or within a specified time period. If your business experiences seasonal or irregular sales activity, try negotiating a flexible rental rate that will correspond to the anticipated changes in your cash flow.

Escalation Clause. This clause provides for specified increases in rent over a specified time. These escalations can be fixed or determined with reference to an outside factor; i.e., increases in the landlord's operating costs, increases in a cost index, or increases in your business's gross receipts or sales.

Improvements and Modifications. This provision identifies whether or not you have the right to make improvements or modifications to the facility so that it better suits your needs. In some cases, a landlord will build or modify a space to suit a tenant's particular needs, prior to the tenant moving in. These agreements must be spelled out in the lease. Additionally, watch out for language requiring you to restore the space to its original condition: if you knock down a wall, you don't want to be stuck with a bill to undo the work.

Maintenance/CAM. This provision determines who is to maintain which portions of building and/or land. If you are responsible, you must make sure the lease specifies whether you can contract with anyone of your own choosing to provide these services, or if these service providers must be approved by the landlord. CAM is Common Area Maintenance - be clear on exactly what the landlord can charge back to you, such as installing a new elevator or stairwell, etc.

Competition. If you are leasing retail space in a larger facility, such as a store in a mall, there may be restrictions placed on the landlord's right to lease nearby space to businesses offering goods or services similar to your own. (If the lease does not include such a provision, you should push for one.)

Subletting. This provision spells out whether - and under what conditions and circumstances - you are entitled to sublease all or part of your premises to another. (Remember, even if you sublet, you are still the one legally responsible for paying the rent, etc. to the landlord).

Should you outgrow the space and want to move, you'll want the right to sublease or assign the space to another company without a hassle from the landlord.

Taxes. This clause specifies who is responsible for the real property taxes or portion thereof.

Insurance and Liability. This provision determines who is responsible for casualty and liability insurance and the amount of coverage to be carried. Additionally, this provision may specify under what circumstances you and your landlord may excuse each other for liability for injury to persons or to the property.

Watch out for language that would legally excuse your landlord from damages to persons or to the leased property caused by the landlord.

Renewal Option. This specifies whether you have the option to renew the lease when it expires and for what amount of rent. Including a renewal option in your lease can protect you from an unreasonably large rent hike when your first term expires.

Purchase Option. This provision spells out whether you'll have the right or obligation to purchase the facility at the end of the lease term. This provision should spell out the option price or range, and how and when the option to purchase can be exercised.

Destruction/Condemnation. This provision states whether the landlord is required to rebuild and specifies whether the rent will be abated and if your lease obligations are terminated in the event the facility is totally or partially destroyed. This provision will also define what rights you and your landlord will have if the facility is taken over by eminent domain (acquired by a government body for a public purpose).

Most leases include a provision for termination of the lease following destruction of the facility based on the time it will take to repair or the costs involved. Insist on a cutoff time after which the lease is terminated to prevent your losing business while a landlord takes forever to make repairs.

Landlord's Solvency. This is a necessary provision protecting your rights as a tenant if your landlord's building - along with your leased premises - are foreclosed upon. If you are concerned about the landlord's solvency before you enter the lease, require your landlord to obtain a non-disturbance agreement from any mortgage holder. This would obligate them to adhere to the terms of your lease even in the event of foreclosure.

Zoning and Land Use Restrictions. This provision spells out the zoning and other restrictions that apply to the building and your use of it. If your intended use would violate a zoning rule or private land use agreement, insist - or have your attorney insist - on a provision that lets you out of the lease if you are unable to obtain a zoning variance or other judicial relief.

Going Dark. In a mall or office building, smaller businesses can be hurt when a major tenant "goes dark" by not renewing their lease or by going out of business. You may want to consider adding a clause to your lease that would give you a substantial rent reduction or the right to close your store if a major tenant or several other tenants go dark.

Security Deposit. This is the amount you'll pay in addition to rent in order to activate the lease. This is in addition to other costs spelled out above.

Ancillaries. Look at clauses related to parking and building hours, etc. when you negotiate your lease. If the AC or heating is normally shut off at 8:00 PM each night and your staff always works late, try to get those hours extended.

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