Whether you are about to sign your first lease or preparing for a renewal for your commercial property, it is essential to thoroughly understand a commercial property rental agreement, also known as a commercial lease.
A commercial lease is a contract between a tenant(business) and a landlord, or a representative of the landlord, a commercial property management expert, giving the tenant the right to use the property for commercial activity for a set period. Unlike in the highly regulated residential leases, your rights are as defined in a commercial property rental agreement. Therefore, it is best you hire a competent attorney when negotiating a commercial lease to ensure the terms and conditions suit your needs and keep away future surprises.
That being said, let us dive into the essential things you should know about commercial property rental agreements.
Essential Things You Should Know About Commercial Lease
Table of Contents
Differences Between Commercial and Residential Leases
Whereas the basic concept and terms of a commercial property rental agreement are similar to an apartment lease, there are key differences between commercial and residential leases you should know before making the big move.
Commercial leases are subject to fewer consumer protection laws, unlike residential leases, which are highly regulated by federal laws. This is because the legal system assumes the commercial lease parties have the same knowledge and experience base. However, a potential residential tenant often lacks the legal knowledge and skills of a property manager or landlord.
There are no standard forms for commercial property rental agreements because most are tailored to the landlord’s needs. For this reason, carefully examine any commercial agreement offered to you to ensure it contains everything you think it should.
While residential leases tend to be one year, followed by the choice to extend the lease on a month-to-month basis, commercial leases are longer, often between 3-5 years. As a result, changing or breaking a commercial lease is more challenging because a good deal of money is at stake.
Typically, residential tenants are responsible for little maintenance and repairs and are required to notify the landlord if anything breaks or needs replacement – the landlord then takes action within a reasonable time. The case is quite different in commercial leases because most tenants take care of maintenance and repairs. The landlord ordinarily maintains the physical building, while the tenant typically takes over the rest. We will learn more about that in our discussion about commercial lease types. But always ensure a commercial property rental agreement outlines the responsibilities of each party.
Distinguish Between the Different Types of Commercial Leases
The following is a breakdown of the different types of commercial leases based on the landlord’s and tenant’s expenses.
1. Net Lease
Perhaps the commonest type of commercial lease, a net lease makes the tenant responsible for the base rent and one or multiple additional expenses associated with the property. Net leases are classified into three types as follows:
- Single Net Lease: Sometimes referred to as N lease, a single net lease is the simplest lease structure in commercial property management. With an N lease, the tenant is responsible for the base rent, utilities, and property tax, while the landlord takes care of building expenses.
- Double Net Lease: Also known as NN lease, a double net lease is similar to the N lease except that the tenant is also responsible for the cost of building insurance.
- Triple Net Lease: Among the most common commercial lease types, triple net lease/NNN lease makes the tenant responsible for all the expenses except structural repairs.
2. Full Service Lease/ Gross Lease
In a full-service lease, the tenant pays a fixed rent each month while the landlord covers all other costs, including maintenance, state and local taxes, insurance, utilities, and management. This lease structure is similar to an all-inclusive resort- one flat fee covers all the amenities. The base rent is relatively high, but it’s the only cost the tenant is responsible for.
For cost flexibility, some landlords try and include additional clauses to a gross lease to account for an increase in taxes and insurance. Some also have a clause that allows landlords to increase the rent temporarily depending on the variable costs.
3. Modified Gross Lease
The modified gross lease or modified net lease provides a good middle ground for both landlords and tenants. In this lease structure, the landlord and tenant split the property’s operating expenses. However, the costs paid by each party can and do vary, depending on real estate market conditions and the negotiations between the landlord and tenant.
Commercial Lease Terms You Should Know
Basic commercial lease terms include the following:
- Lease term (length of lease): Learn when the lease begins, how long it will extend, and whether renewal options are available. Also, ask if the lease will end on a specific date or under certain conditions.
- Rent: Ask about the base rent and other charges and whether the landlord increase rent periodically.
- Security deposit. How much is the security deposit, and under what conditions does the landlord return it?
- Rentable area: Exactly how much space are you renting (including common areas like a loading dock, elevators, lobby, and hallways), and how does the landlord obtain the measurements?
- Usable space: What is the actual amount of space reserved for business?
- Lease termination: Are lease termination options available? What is the lease termination process? Are there charges for early lease cancellation?
- Assignment and subleases: Can you assign or sublease the commercial lease to another tenant?
- Late fee: If the tenant delays rent payment, how much late fee will they incur? The charge can be a flat fee or a percentage of the monthly rent.
- Option to purchase: This is an optional clause that states that the tenant has the right to buy the property at any time during the lease and an agreed-upon price. It can also prohibit the tenant firm from purchasing the property during the lease term.
- Grant of lease: It is a clause that states that the landlord will hand over the property to the tenant once all conditions are fulfilled.
- Holdover rent: Refers to the rental price a tenant pays when they stay longer than their current lease allows. In such a situation, you may end up paying double the amount of your typical monthly rent, and this could cost you tens of thousands of dollars. Aim to negotiate the handover rent down to about 130%.
- Nondisturbance agreement: It protects your business from eviction should the landlord default on mortgage payments, even if you are up to date with your expenses. It allows you to continue making payments to the management entity that takes over the property from the landlord.
Learn More about the Area, Landlord, and Applicable Laws
It is highly recommended you conduct thorough research before signing a commercial property rental agreement. Take the following steps:
» Understand the Area
Location is central to a small business’s success, so take time to analyze a neighborhood and the local clientele to find an ideal new home for your business.
Also, note that the current market incredibly influences the landlord’s negotiating power. It won’t be easy to negotiate the rental rates for a unique property or when there are few available options. Instead, negotiate the perks. However, a market with many commercial spaces allows you to negotiate both perks and rental rates.
» Learn More About the Landlord/Property Owner
Often overlooked, researching the landlord, property owner, or the commercial property management agency managing the building is critical for commercial tenants. You will want to know who the landlord and property owner are and their financial position.
There exist scenarios where tenants have been evicted during a foreclosure due to the landlord’s failure to make payments to the owner or mortgage payments to a bank. That is just an example of how awful the relationship between property owners, landlords, and tenants can turn. Safeguard yourself from tribulations by performing a public-record search or requesting documents related to the landlord’s business to determine if the landlord is the ideal partner for your business.
If you are dealing with a commercial property management firm, learn about its competence.
» Research Zoning and Nuisance Laws
While a landlord may designate a space for your business, it is your responsibility to ascertain the move complies with the local zoning laws. Zoning laws stipulate the type of business that can occupy a particular area and the activities it can conduct there. Failure to research the rules can be a recipe for major legal complications from the town or city you serve.
Your business can fall prey to local environmental and nuisance laws if you fail to do your due diligence on the commercial property. Check for points on smell, equipment, and noise in the lease; else, ask the landlord about them. And do not forget to learn and understand the basic environmental laws the property is subject to before signing anything. This goes a long way to help you run your business in full capacity once you open its doors.
Negotiating a Commercial Rental Agreement
When negotiating a commercial property rental agreement, have with you a list of features you are looking for in a commercial property, including the must-haves, would-be-nices, and the really-wants. This information helps streamline the bargaining process and ensures your needs are met. For example, you could trade for an unneeded parking area (a would-be-nice) in exchange for free Wi-Fi (a really-want). To increase your counterpoints in the negotiation, draft a list of undesirable features or areas in the property that need improvement.
Commercial property management experts and landlords usually quote leases in price per square foot. However, landlords often recycle lease agreements, which means the documents may not be up to date with current space due to repairs, remodeling, or measurement errors. With that in mind, the worst mistake you can make as a business owner is not verifying the space you intend to rent. You could be overpaying.
You also want to be extremely careful with the escalation clause- it allows the landlord to increase rent to cover any increase in their properties’ expenses. Whereas escalation clauses are common and valid, they can be massive money traps for tenants, especially when an aggressive landlord is paired with a beginner tenant. Do not sign a commercial lease without negotiating a cap on the escalation clause.
You will need a commercial space to be renovated to suit your needs. You may need to create a certain layout, move walls, rewire for better communication or lighting, or bring in specialized equipment. The lease should specify the party responsible for the renovation costs. Typically, landlords handle the renovations while the tenant pays rents, or the tenant pays for the upgrades but not rent during the construction period.
Changing or Getting Out of Commercial Lease
The landlord is not allowed to change a commercial lease on their own. Normally, they have to wait until the next renewal or have the tenant agree to the changes. An exception to these requirements comes in if the lease includes a clause that allows the landlord to terminate the lease when property ownership changes hands. A notary should witness the landlord’s and tenant’s signatures to make amendments legally enforceable.
Whereas the landlord has the right to expect the tenant to complete the lease term, a tenant has the option to terminate the lease if they are making losses or need to relocate their business. The landlord may have the right to sue the tenant for the remaining rent. In some states, the property owner or manager may be required to re-rent the space and offset the rent they receive against the amount owed by the tenant.
Another option for tenants is to sublet the commercial space to another tenant. But note that some leases restrict or prohibit subleasing. In subleasing, the original tenant is responsible for any defaults by the sub-lessee and any term in the original lease not accounted for by the new tenant. So, if the sub-lessee fails to pay rent, the sub-lessor is required to pay the landlord.
You can also assign a commercial lease to another tenant and get the landlord or commercial property management company to relieve you of all the responsibilities.
The Bottom Line
A lot goes into a commercial lease, and getting the basics right goes a long way to ensure a smooth lease term while keeping you away from legal and financial complications.
To learn more about commercial property investment and rental leases, you can contact RTI Properties, a top-rated full-service property management company in Southern California. We can leverage our decades of experience in commercial property management to help you find the next home for your business. Call us today at (310) 532-5994 or contact us online for a free initial consultation with one of our commercial property managers.