Deciphering the Code: Understanding Commercial Lease Terms
February 2, 2024
Deciphering the Code: Understanding Commercial Leases
Taking on a commercial lease is a significant step for businesses of all sizes. In this insightful third entry of our "Lessons in Leasing" series, we delve into the essentials of commercial leases and lease terms, providing you with the clarity needed to navigate these agreements confidently.
Understanding Different Types of Commercial Leases
The type of commercial lease you enter can have substantial implications for your business's financial planning:
- Net Lease: Involves paying base rent along with one or more additional expenses like property taxes, insurance, and maintenance. You will often see this referred to as NNN or NN, Operating Expenses, and CAM. We will explore these definitions further. The lessor should be aware that landlords and owners may not use these terms consistently so it is imperative that you, as the tenant, be aware of their definition.
- Gross Lease: You pay a fixed rent, and the landlord typically covers most property-related expenses, offering simpler financial planning. These type of leases can also save the tenant significant start-up costs by avoiding utility deposits. Be sure you understand what services are being provided. It is becoming more common for landlords to provide wifi services; however, they typically do not provide telephone, individual office security or janitorial.
- Percentage Lease: Common in retail, combining base rent with a percentage of sales revenue, linking your rent to business performance. This can be attractive in the beginning stages of a business; however, the tenant should be sure they are looking at the pro-forma revenue numbers and increasing their rents accordingly to get a true picture of the future cost.
- Modified Gross Lease: This lease offers a middle ground where you and the landlord share property expenses. Rent includes some property costs, but not all, allowing for negotiation over specific expenses like utilities, janitorial services, and minor repairs.
Expanded Key Lease Terms to Know
A thorough understanding of your lease terms can prevent unforeseen liabilities and costs:
- Lease Term and Renewal Options: Details the lease duration and renewal conditions. If you have to give a certain number of days to enact a renewal be sure you are setting reminders so that you do not miss these important deadlines.
- Rent Escalation: Defines how and when rent increases are applied.
- Termination Clauses: Specifies conditions for lease termination.
- Subleasing Rights: Outlines rules for subleasing the space along with any costs you may be charged for the landlord to administer the sublease.
- Repairs and Maintenance: Delineates responsibilities for maintenance and repairs, ensuring clarity on who handles what. Be aware that just because a landlord may be responsible for making the repair, you as the tenant may be responsible for paying for the repair. This also applies to Preventative Maintenance requirements within your lease.
- CAM (Common Area Maintenance) Fees: Covers shared space upkeep, you need to know what's included and the calculation method. When spaces are shared one party must be responsible for maintaining them this falls on the landlord; however, the tenants chip in and pay their proportionate share.
- NNN (Triple Net) Fees: In a triple net lease, you bear the costs of property taxes, insurance, and maintenance in addition to rent.
- Who Pays for What: The lease should clearly state financial responsibilities for utilities, repairs, and enhancements. Often, a property will have a shared meter for water, trash or electricity, these expenses usually get billed back to the tenant for their proportionate share.
- Default Provisions: Understand the implications of lease violations or late payments, including penalties and grace periods.
Navigating the Lease Application Process: Best Practices for Success
A compelling lease application can significantly influence a landlord's decision. Here are some strategies to strengthen your application:
- Creditworthiness: Keep your financial records organized and transparent to demonstrate your business's stability, being organized with your financial information can help demonstrate to a potential landlord that you handle this side of your business well and know the importance of paying your rent on time.
- Essential Documents: Have your financial statements, business plan, and references ready. When a business is new, you may not have previous years' financial statements to provide, this is when having a business plan and references is very important.
- Landlord's Requirements: Understand and meet the specific criteria set by landlords to ensure your application complies. If you cannot provide all the information or meet the specific criteria ask if there is an alternative. You may be able to add an additional guarantor or pay a larger deposit.
- Professional Advice: Seeking guidance from a commercial real estate professional or attorney can provide you with a competitive advantage.
Understanding the nuances of commercial leases is vital for making informed decisions that align with your business objectives. With a clear grasp of different lease types and key terms, you're better equipped to negotiate terms that benefit your business. Always approach these agreements with careful consideration and seek professional counsel when needed.
Stay tuned for our forthcoming "Lessons in Leasing" post, where we'll cover the lease lifecycle, tenant considerations, and more in detail.