Leasing a commercial property is a bit more complicated than renting a residential property. This article will set forth standard lease clauses for small business owners and those engaging in commercial real estate investing to include or look out for, and how the two major types of commercial leases are beneficial and detrimental to small business owners.
What is a Commercial Lease?
A commercial lease is a contract between the property owner, called the landlord, and the business that operates on the property, called the tenant. A commercial lease defines each party’s rights and responsibilities as to the property.
Common Terms in a Commercial Lease
A commercial lease may be difficult to understand due to its length and legalese. Here are ten aspects of a commercial lease every small business owner should be able to understand and identify in any commercial lease they are considering signing on behalf of their company. Understanding your lease thoroughly helps you manage risk and anticipate your cash flow.
- Defining the Premises to be Leased
If a commercial property has several offices, units, or other leasable spaces, the lease must specify which of these the tenant has the right to occupy. The unit number and square footage of the unit should be set forth in the lease. The lease may also describe the common areas and the tenant’s right to use those areas.
- Setting the Lease Term
Every commercial lease will include a start date and an end date bracketing the lease term. This clause may also provide for possible lease extensions under defined circumstances.
- Establishing the Amount of Rent
The tenant must remit monthly rent payments to the landlord in exchange for the right to occupy the premises. This clause may also set forth the amount of security deposit required and whether the rent amount will increase during the lease term.
- Permissible Use of the Premises
All leases expressly state that the tenant may not do anything illegal on the leased premises. Some leases will specify what illegal activities are prohibited, such as drug production or distribution, or gambling.
A retail lease will often specify what types of business a tenant may not run in the leased space to protect the exclusivity of other tenants. For example, if a strip mall already has a coffee shop tenant, the lease may specify that the new tenant may not open a coffee shop on the premises.
- What Constitutes Default
A commercial lease will specify what acts constitute default by the tenant. Of course, failure to pay rent is a default, but if a tenant fails to adhere to other terms of the lease, such as a prohibition on certain types of business or illegal activities, that may constitute default as well.
This clause will also set forth the consequences of default, such as late fees, interest charges on late rent payments, and eviction.
- What the Tenant’s Rights to Cure Are
This clause will set forth the circumstances and timeline under which a tenant can cure the default. If the tenant fails to timely cure a default, the tenant may be evicted.
- Whether there is a Tenant Improvement Allowance
For commercial leases involving retail and office buildings, a tenant improvement allowance is common. These types of tenants have specific needs from their leased space.
This clause will set forth how much of the expense to customize the premises for the tenant will be absorbed by the property owner. Property owners often use this clause to provide incentives for prospective tenants to sign the lease.
- Whether and When Co-Tenancy is Permitted
In retail leases where smaller businesses rely on the traffic generated by larger businesses, this clause may specify how much rent relief the smaller businesses may receive if the occupancy of the entire building falls below a certain percentage.
As a small business owner, you should take note of the landlord’s offer in this clause. If there is no co-tenancy clause, you might negotiate to have one added.
- Whether and When Assignment is Permitted
This clause will specify whether the tenant has the right to assign the lease to a third party. If an assignment is permitted, the clause will set forth the circumstances under which the lease may be assigned. Usually, the property owner’s approval of the assignee is required.
- Whether and When Subleasing is Permitted
As in the Assignment Clause, the Subleasing Clause will set forth whether a tenant may sublease all or some of the leased space. The right to do this is very beneficial to small business owners if they find they have leased too much space and wish to cut expenses by taking on a sublessee.
Full-Service Gross Leases
What is a Full-Service Gross Lease?
A full-service gross lease defines the parties’ rights and obligations this way:
- Tenant pays monthly rent
- Landlord pays all operating expenses as well as for maintenance of the common areas
What Are the Benefits of a Full-Service Gross Lease for a Small Business Owner?
First, a small business owner knows what their monthly rent is, without variation. Second, a small business owner does not have to be concerned with paying utilities. Third, a small business owner has areas in common with other tenants maintained by the landlord.
Are There Any Detriments to a Full-Service Gross Lease for a Small Business Owner?
There may be. A landlord may set the monthly rent a bit higher, knowing that they must cover utilities and maintenance of the common areas.
For landlords, the downside is that there is no incentive for tenants to conserve utilities or take care of the common areas.
Triple Net Leases
What is a Triple Net Lease?
In a triple net lease, often called an NNN lease, the tenant pays their share of utilities, insurance, maintenance such as landscaping and janitorial services, and perhaps property tax in addition to monthly base rent. A tenant’s share of these expenses is usually determined by the square footage of their leased space relative to the property’s total square footage.
What are the Benefits of Having a Triple Net Lease for Small Business Owners?
The primary benefit of entering into a triple net lease is the low base monthly rent, compared with the rent set forth in a full-service gross lease.
For landlords, single tenant triple net leases, often executed by bank branches, drug stores, and quick service restaurants, require little oversight.
What are the Detriments of Entering into a Triple Net Lease?
A small business owner entering into a triple net lease exposes their business to rising operating costs such as property management, janitorial services, property tax, and utilities.
Landlords may be attracted to a triple net lease because they have less responsibility regarding the property. However, a triple net lease situation involving more than one or two tenants can quickly become burdensome to administer.
Hopefully, this article gave you a foundational understanding of commercial leases so that you can enter into a lease on behalf of your small business with eyes wide open.
About the Author
