When you sign a commercial lease, it is a legally binding contract. It is important to fully read and understand the terms within the contract, so you understand your responsibility as either the tenant or the landlord. This is a brief overview of some of the items to be aware of in commercial real estate leases and is by no means a comprehensive breakdown. It is always important to have a lawyer or legal team review any commercial real estate leases.
Dates (Commencement Date, Rent Commencement Date, Expiration Date, and Lease Term):
When it comes to a commercial lease there are various dates to be aware of. You will want to know when your lease officially starts, when you start paying rent (which may or may not be the same date as the commencement date), and when your lease ends. The landlord and tenant will agree upon an acceptable lease term which could be days, years, or months.
Money Owed Upfront and Over Time (Security Deposit, Prepaid Rent, Payment Schedule, Late Fees, and Default):
It is vital to have a clear understanding of what you owe once the lease is executed. This can include a security deposit and/or prepaid rent such as first month’s rent and/or or last month’s rent. You will also want to familiarize yourself with the schedule. What do you owe over the course of the lease? Does it increase over time? Does the lease require percentage rent? If so, you will want to budget accordingly. Furthermore, if you don’t pay your rent before the determined due date, what late charges will you have to pay and what are the default consequences? It is important to understand what your obligations are under the lease as you may be subject to late fees, legal fees, or other financial consequences if you do not pay on time.
Lease Type
Depending upon the type of lease you have, different rates apply to different contracts. Is your lease a triple net (NNN), modified gross, gross, or other type of lease? If it is triple net (NNN), what do the operating expenses (OE) fees include? CAM (common area maintenance) is another term to be familiar with which typically includes management fees, administrative fees, roof repairs, landscaping, parking lot maintenance, building repairs, etc. Additionally, if a lease is triple net real estate taxes and insurance are also included in operating expenses. The majority of leases call for an operating expense reconciliation process after year end (a true-up or reconciliation of your monthly operating expense contribution for the year compared to your actual pro-rata share of the operating expenses for the year). In some instances, you may owe an additional amount for operating expenses and in some cases, you may receive a refund if you overpaid for the year. Real estate professionals can provide more information about operating expenses and CAM. You can talk to an agent, broker, commercial property management company, and/or real estate lawyer.
Gross Receipt Reporting
Many leases require the reporting of gross sales or receipts to the landlord and in some instances percentage rent may come in to play. This occurs if your sales for a certain period of time eclipse a predetermined breakpoint amount that will be noted in the lease. Essentially, if your sales go over a specific amount you may have to pay a percentage based on your gross sales.
Use
Leases typically have use clauses that outline what type of business you will be permitted to conduct at the premises. For example, if your use is for cutting hair you cannot conduct other types of business in the premises.
Common Area
There are certain areas on the property that may be considered common area, understand your responsibilities associated with common areas including allowed parking.
Tenant Responsibilities and Landlord Responsibilities
You will also want to make sure you have a clear understanding of who is responsible for what. For example, if repairs need to be made to the roof, HVAC, walls, or foundation, who is responsible for repairing the items? There may also be deadlines for repairs and proof the repairs were completed satisfactorily. Tenants may also be responsible for maintaining specific items within the space.
Business License and Occupancy
Depending on your location, your city and/or county may require certain licenses in order to conduct business or occupy the premises. This should be researched prior to signing a lease to ensure your use is permitted and what costs may be associated with any such licenses or permits.
Utilities
Based on the type of lease you have signed, you may or may not be responsible for the payment of utilities. Additionally, if you install something for utility function you may have to seek landlord approval. Expenses for these types of projects may be at the expense of the landlord or tenant depending on the circumstance.
Alterations
If you plan on altering the space in any way you are encouraged to contact the landlord to see if their approval is needed. Additionally, it is also important to understand that anything that becomes permanently attached to the premises may become the property of the landlord after the commercial real estate lease expires, please review your lease accordingly to fully understand the alteration/improvement process.
Signs
If you want a sign for your business, the landlord may have to approve it. Some signage may also not be permitted. There may also be specific style choices that the landlord wants to ensure continuity at the property. Signage may include window/door signs, storefront signage, marquis signs as well as monument and pylon signs. Not all such signage is available at every property, and you should be sure to negotiate any desired signage in the commercial real estate lease agreement.
Personal Property (FF&E)
As a landlord or as a tenant, ensure you know the terms surrounding personal property (furniture, fixtures, and equipment). If for example, there is a leak, or a pipe burst and it causes damage to personal property, who is responsible for recovery, replacement, or repair?
Insurance
The lease will typically describe the type of insurance you need to lease the space. It may breakdown the specific type of insurance you need, what limits are required as well as the deadlines in which you need to provide proof of your insurance to the landlord. Typical types of required insurance are liability, property and rent loss. It is always a good idea to discuss the insurance requirement in the lease with your insurance provider to understand the costs associated with obtaining any necessary coverage.
Entry
You will want to know when the landlord is allowed access to the unit. This may be because of repairs needed to be made. Landlords might have to provide tenants with advance notice. Right of entry protocols are typically included in the lease.
Assignment and Subletting
You may or may not be allowed to sublet or assign the space, typically landlord approval will be required.
Moving Out
When you move out, there are usually expectations regarding the condition of the space when it is returned. The contract may also address how the space must be returned to the landlord. Additionally, leases usually have holdover language that allows a consequence if the tenant does not vacate or renew the commercial real estate lease, typically this would entail monthly rent increasing to 150% -200%.
Lease Exhibits
Many leases will include exhibits which can range from personal guaranty’s, rules and regulations, legal descriptions, construction, special stipulations, etc. A full understanding of all exhibits should be part of a tenant’s due diligence process before signing a lease.
While we covered the basics of what you might see in a commercial real estate lease, this is not a complete description of this legally binding contract. It is solely a highlight of some of the items to be aware of that are frequently addressed within commercial leases.
If you want to find additional information about the different types of commercial real estate properties, click below.
The 4 Major Types of Commercial Real Estate Properties
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