If you’re hoping to make real estate investments, buying commercial real estate outright may not be the best option. One alternative could be leasing commercial property instead. If you’re unfamiliar with how commercial leases work, don’t worry – it may sound complicated, but it’s pretty straightforward! This guide will walk you through everything you need to know about leasing commercial real estate, including what the terms mean and the components and requirements of a commercial real estate lease.
What is a Commercial Real Estate Lease?
A lease is an important document or contract that outlines all the terms and conditions under which a landlord rents a commercial property to a tenant. A commercial lease is very different from a residential one for many reasons. In a commercial lease, the tenant rents the property for running a business or for some profitable activity.
In contrast, a residential lease focuses on living space with little negotiation. A commercial lease has multiple components and requirements, and each of them should be probably researched and understood before signing a lease. The lease includes the details about:
- Parties clause
- Premises clause
- Rent clause
- Term clause
- Permitted use clause
- Exclusive use clause
- Details about the security deposit, maintenance and renovation
Before going into the details about the lease requirements, we should see into the types of commercial real estate leases:
Types of Commercial lease
Before signing a commercial lease, you should be familiar with all the relevant terms regarding the commercial leases, also including learning about different types of leases.
Leases are complicated and require extensive research about the payment structure, demands and laws. The types generally revolve around the base rent, which is paid by the tenant and the difference in the operational expenses, whose payment is different in all types.
Gross / Full-service lease:
It is the most popular commercial lease used in the market. In the gross lease, the tenant only pays the base rent while the landlord pays the operational expenses.
The base rent is high in this lease, so the landlord usually pays the rent expenses like utility bills, maintenance, taxes etc., and the rent. Most tenants prefer this lease because they aren’t bothered by these operational expenses daily.
They have to pay their only cost, which is rent, and it’s fixed. That doesn’t change the fact that some landlords add escalation clauses in the lease if some tax or insurance increases, so the rent is temporarily increased.
Net leases are the leases which are further modified into subcategories. In the net lease, the tenant also pays expenses other than the base rent. In these leases, the base rent is lower than the gross lease because the tenant also contributes to paying the operational expenses. The further categories are:
- Single-net lease: The tenant pays the rent and fixed operating expenses such as property taxes or maintenance or utilities. The landlord usually pays the building expenses.
- Double-net lease: in which the tenant also pays a part of property insurance and tax while also paying for the utilities. The landlord takes care of the common area maintenance.
- Triple-net lease: the tenant pays for almost all the operating expenses and base rent. This allows the tenant to monitor all the expenses, and saving also goes to the tenant. This lease benefits the landlord but is sometimes more profitable to the tenant.
As the name suggests, this lease is a modified type of commercial lease. It provides a middle ground for both parties. The agreement is made after a couple of negotiations about all clauses.
Requirements for Leasing a Commercial Real Estate
As mentioned above, different clauses are included in the commercial lease, and all of them are essential components of the lease. These are all the terms you should know about in detail.
- Rent clause
- Lease term
- Permitted use clause
- Exclusive use clause
- Lease type
- Rent amount
- Details about maintenance and renovations
The rent at which the property has been leased is the first and foremost clause included in the lease. The rent has two components; a base rent and percentage rent.
The base rent is fixed between tenant and landlord. It is determined per square footage, and it is to make sure that it represents the usable space. The percentage of rent is more than the percentage of the business’s gross sales.
The term of the commercial lease is a distinguishable point between residential and commercial leases. These are long-term, probably up to 3-5 years and well negotiated and low maintenance leases. It specifies the start and end dates of the lease.
Permitted use clause
This clause is very important for both the tenant and the landlord because it specifies for what purpose the premises of the property would be used. The activities that can be performed on the property are specified. The tenant cannot use the real estate for any other business than what’s mentioned in the lease. Otherwise, the contract is violated.
Exclusive use clause
The tenant should properly discuss the exclusive use clause. It is what the name specifies that offers the exclusiveness of the business to the tenant. This helps in the long term so that the landlord doesn’t rent another competition business into the building.
There are a few different lease types that you can choose from when leasing a commercial property.
- Operating Lease – This is a typical month-to-month lease. The lessee pays the rent and other expenses such as utilities and maintenance. The lessor is responsible for the maintenance and upkeep of the building. –
- Sales and Service Lease – The lessee promises to use the space for a specific purpose with this lease type. For example, the lessee might promise to operate a restaurant in the building.
- Lease with Life of Lease – A lease with a life of the lease is a long-term lease agreement. This is generally used for properties leased for a long time, such as multi-year leases.
No one rent amount works for all leasing types. The amount should be based on the type of lease and the location of the leased property. For example, a single-story, 10,000-sq.-ft. Building in a small city might rent for $1,100 per month. A large, 20,000-sq.-ft. building in a large city would be more expensive, likely renting for $2,000 per month.
Details about maintenance and renovations
When leasing commercial property, it’s important to understand the details of maintenance and renovations. This means that the lessee is responsible for any maintenance and renovations in the building. In some cases, the lessor may agree to make maintenance and repairs in exchange for a higher rent.
Make sure to ask the lessor what they expect in return for making these repairs, so you know what to expect. All in all, commercial real estate leasing can be a great way to expand your business. However, it’s important to understand the risks involved with investing in CRE.
Legal Requirements for Leasing a Commercial Property
As mentioned above, leasing is a much less risky acquiring property than purchasing it outright. That being said, you must know the legal requirements for commercial property leasing. For example, in some states, you must obtain a permit before leasing a building. Make sure you understand which requirements apply to you and your leased property. –
This is a must if you’re leasing a piece of property.
The lease agreement should outline the lease terms, including rent amount, term length, and any rental increases.
This is the amount that tenant pays when signing and finalizing the lease. It is not an additional amount. It’s more likely some damage deposits if the tenant damages the property and can’t pay the rent. The tenant keeps the property in good condition at the end of the lease and complies with the terms and conditions.
Make sure you know of any legal requirements for conveying the property. For example, in some states, you must always be the property owner when it’s being leased.
Advantages & Disadvantages of Commercial Real Estate Leasing
There are several reasons why leasing a commercial property is a smart idea for a business.
|Less Expensive – Commercial real estate can be significantly cheaper than buying a piece of property. This can be especially true in cities with a lot of vacant space.||Risky – Since you’re not buying a piece of property, leasing may be a higher-risk investment than building a new facility.|
|Simplicity – Commercial real estate can be much simpler than buying a building.||No Equity – Since you’re not buying a piece of property, there is no equity involved in leasing.|
|Flexibility – In addition to being able to move if the business does, leasing space can also give you the option of changing your business model at any time.||No Future Property Value – As long as you meet the required lease terms, you don’t have any control over the future property value.|
|Speed – If you plan on expanding, leasing lets you quickly put more space on the ground and start making money.||Difficult to Determine Future Cash flow – Because leasing isn’t an equity-based investment, it’s difficult to determine your future cash flows.|
Frequently Asked Questions
What should be included in a commercial lease?
Keeping in mind that you should seek professional advice before signing a lease, here are a few key factors to consider:
- Lease duration/type
- The amount of rent
- Deposit of security
- Allowable usage
- Use only once
- Upkeep and renovations
- Outside appearance
- Personal assurance
- Clauses for amendment/modification/termination
Is there an arbitration clause in the lease?
Arbitration clauses are now common in many contracts. These clauses state that both parties agree to resolve disputes through arbitration rather than court. Examine the lease contract to see if the arbitration clause is required. If arbitration is agreed upon, ensure that you have the right to participate in selecting the arbitrator and other decisions for arbitration.
Will a personal guarantee be required?
Most landlords will refuse to sign unless you guarantee the lease, so consider yourself extremely fortunate if you can sign a lease without such a clause.
However, the nature of guarantees can be negotiated. Consider providing one for only a portion of the lease term, or negotiate a guarantee that only lasts six to twelve months after you terminate.
Is it possible to have a sublease?
Taking on a sublease is a common practice, similar to assigning a lease. A sublease is another company that works in your lease space under the terms of your lease. You pay the lease, and the other party contributes to the cost. Many landlords do not allow subtenants, but you may want to share expenses with someone down the road. Negotiate with the landlord before signing the lease if you intend to hire a sublease.
A commercial lease is a binding law agreement between the landlord and the tenant. A commercial lease is well negotiated, but low maintenance compared to the residential lease and includes additional clauses.
Commercial leases are of different types with similarities regarding base rent and differences in paying operational expenses. The requirements of a lease include the security deposits, lease term, permitted use clause and exclusive clause.
Sheena Whitlock, a property expert, and blogger with over 15 years of experience in the field. The knowledge and skills Sheena has acquired during her career have given her invaluable insight into the property management business.
She has done her Property Development BSc (Hons) from the University of Portsmouth and completed her Master’s Degrees in Property Management from the University of Chicago.
As a professional, she has spent time working for various companies as a property management officer and currently works at Asset Info Hub where she shares her knowledge and experience on various property matters with people around the world, questioning their queries via blogging and virtual consulting services.