Thinking of leasing commercial space for your business? Before you speak to a potential landlord, it is important that you understand how commercial leases work.
Successful business leasing requires:
- Thorough understanding of the different types of leases;
- Having an ally in your corner – your Real Estate Broker;
- Making sure the lease fits business needs and future growth plans;
- Never signing anything until your attorney reviews it!
It’s important to first point out that commercial leases are very different from residential rental agreements. Commercial leases are legally binding contracts and breaking a lease has serious financial consequences. On the bright side, commercial leases are typically negotiated to fit the needs of your unique business space and methods of operation. This negotiation stage is critical to ensure you are setting yourself, and your business, up for success. Having an experienced commercial real estate broker helping you not only search for the right space, but negotiating your needs for you, can make or break a good deal.
Types of Commercial Leases
We’re accustomed to commercial real estate being rented at a square footage rate, but how that is being determined is essential when evaluating a lease agreement. Terms of commercial leases vary dramatically based on the type of building, what different industries require, and popularity of particular geographic areas – these all drive square foot costs. So why are some spaces more than others? When is something “a good deal”?
There are three common types of commercial real estate leases: Gross, Triple Net (NNN) and Modified Gross. They each ultimately indicate how much the tenant pays for base rent, along with a portion of the associated expenses of the building. Some leases include most building expenses, others include very few, all attribute to the ultimate cost per square foot you will pay to rent space for your business. Terms of individual leases vary tremendously, but this provides an overview:
Gross Leases
A Gross lease basically means a tenant pays one lump sum for rent which includes associated building expenses (real estate taxes, utilities, building insurance, property maintenance, etc.). You may have to pay IT/telecommunications costs, and any unique business fees for services you may require. Sometimes excess utility consumption is charged back to the tenant, and you will need your own property insurance.
Triple Net (NNN) Leases
Triple Net leases have smaller base rent amounts, but other expenses are also paid for by each tenant, and need to be considered in your total square foot costs. In NNN leases, common language includes reference to CAMS, or Common Area Maintenance, which includes janitorial services, property management, landscaping, building maintenance and repairs, and other expenses associated with the common shared areas or services of the building and its tenants. CAMS are calculated on an annual basis. If you lease 10% of a building’s square footage, you will also pay 10% of the associated costs (utilities, insurance, taxes, maintenance).
Modified Gross Leases
A Modified Gross lease is sort of a happy compromise between Triple Net (NNN) and Gross leases, with the party responsible for various building costs shared between the landlord and the tenants. Perhaps the rent is offered at $13.00/SF and includes real estate taxes, building insurance, and the heat. However, each of the individual spaces have their own electrical box, so each tenant is responsible for their individual electrical use, and the maintenance costs are pro-rated according to the percentage of leased space.
Important Lease Factors to Consider:
- Lease Term: when the lease begins, the length of it, and termination and renewal options
- Lease Amount: what is the rent, when is it to be paid, and are there allowable escalations (increases)
- Security Deposit: how much and what are the conditions for its return
- Sub-Lease Terms: can you assign or sublet the space
- Size: what is useable now, what is “deemed to be”, etc.
- Inclusions: are insurance, property taxes, maintenance costs, etc. included in the lease (gross lease), or will some be paid for independently (NNN lease)
- Clear description of the space: what are you renting, are there common areas included (or restricted), how is the space measured? Is parking included or is it a separate fee?
- Build Out: are there improvements, modifications, or other changes allowed for the space, who will pay for them, who owns what following any changes
- Signage: where and how can you identify and advertise your business
- How is the building, and its spaces maintained, including HVAC equipment
- How will disputes be handled
Bottom Line
When evaluating your options for business rental space, it is very important to understand the different types of leases, and all the variables that may be going into a lease’s terms. Ask for a history of the operating expenses of the building that you are considering. This is something that your real estate broker will ask for and review with you.
When looking at any lease, you always need to ask, “What is included? What is not included?” While there are vast differences between the different types of commercial leases, very often square foot costs really end up at the same market rate, no matter how the expenses are allotted. Always have an attorney review your lease, as this is complicated legal language, and changing a lease after it is enforced is very difficult and rarely done.
Special thanks to Magnusson Balfour Broker Craig Church for his valuable input into this article!