Once you’ve found the ideal commercial space to lease, the next step is to know the types of lease clauses and terms you’ll likely see when renting commercial real estate. Before sitting down at the negotiating table, take a few minutes to read and understand how to decode the language and terms of a commercial lease.
Common Commercial Lease Types
There are three types of commercial leases you will find when you rent a commercial property:
Gross Lease
There are two common types of gross leases used with commercial properties:
- Full Service Gross (FSG) is all-inclusive rent with the tenant paying the same fixed rate every month for base rent and all services such as electric and water, janitorial, maintenance, and common area maintenance (CAM).
- Modified Gross (MG) includes the base rent; the landlord and tenant agree in a contract to split operating expenses, such as the tenant paying for utilities and janitorial while the landlord pays for CAM, property taxes, and insurance.
Percentage Lease
Often found in retail commercial leases, a tenant with a percentage lease pays a fixed base rent each month plus a percentage of gross sales above a certain amount.
For example, assume the tenant agrees to pay 3% of any gross sales at or above $250,000 per month, and the base rent is $5,000. If the month’s gross sales were $500,000, the tenant’s rent for that month would be $12,500.
Net Lease
A net lease helps to improve a property owner’s NOI by passing expenses through to the tenant. On the other hand, tenants may have more control of the property when renting space with a net lease.
The “nets” in a commercial lease refer to utilities and property tax, building insurance, and CAM:
- Net lease includes base rent + utilities and property tax
- Double net lease includes base rent + utilities and property tax + building insurance
- Triple net lease includes base rent + utilities and property tax + building insurance + CAM
For example, assume the tenant has an industrial property lease for 5,000 square feet in a 50,000 square foot building at an annual rate of $20 per square foot.
If the building’s total operating or NNN charges are $7 per square foot per year, the tenant’s total rent would be $100,000 base rent + $35,000 NNN charges (pro-rata share) = $135,000 total annual rent, or $11,250 monthly rent including base rent and NNN fees.
Agreement Clauses in a Commercial Lease
Commercial lease clauses are written to comply with state and local contract and zoning laws. Standard agreement clauses in a commercial real estate lease include:
Parties
The legal name and address of the landlord (lessor) and tenant (lessee). Tenants renting commercial space should make sure to use the name of their LLC or corporation on the lease.
Premises
Describes the building and location, including total square footage of property, size of space being leased, and access to shared space such as parking and conference rooms.
Use
Limits how the space rented can be used, such as medical office space or hair salon retail space. This is often used in conjunction with an “exclusivity use clause” that prevents landlords from leasing space in the same property to the same type of business.
Term
The beginning and end of the commercial lease contract, including dates for pre-possession to make tenant improvements (TIs) and options for renewing once the initial lease term ends.
Rent
Rental obligation including base rent, share of operating expenses passed through from the tenant to the landlord and scheduled annual rent increases.
Security Deposit
Amount of security deposit collected by the landlord to ensure the rent is paid, and provisions for returning the security deposit to the tenant at the end of the lease.
Improvements
Describes improvements and alterations to be made to the space leased, whether landlord or tenant pay for the TIs, and if improvements are paid for in cash, with a rent credit, or a rent abatement.
Maintenance
Explains the tenant and landlord responsibilities to maintain the property, such as minor repairs like broken glass and interior plumbing, and capital expenses such as replacing an HVAC or repaving the parking lot.
Parking and Signs
Lists the location and amount of signage a tenant may use, limitations to window and street-front signs, and if any parking spaces are reserved for the sole use of the tenant and its customers.
Insurance
Standard insurance clauses include property and liability insurance for the tenant, rental interruption insurance, and building hazard insurance for the entire property.
Other
Common miscellaneous agreement clauses in a commercial lease include:
- Sublet options
- The option to renew or first right of refusal if the property is listed for sale
- Early termination of the lease
- Personal guarantors
Key Terms to Know in a Commercial Lease
The Society of Industrial and Office Realtors (SIOR) has compiled a 22-page glossary of about 200 real estate terms found in a commercial lease agreement. Some of the most common terms to know in a commercial lease include:
- Additional rent is a variable monthly rent such as CAM or percentage rent
- Anchor tenant is the main tenant that draws business and foot traffic to the property
- Arbitration is a type of dispute-resolution process mediated by a neutral third party
- Assignment means transferring the remaining lease term to another party
- Base rent is the minimum rent due as described in the commercial lease
- Base year is the first year of the lease and can be used to calculate CAM or rent increases
- Certificate of occupancy is a legal notice provided by the municipality stating the building or suite meets all zoning and building ordinance and is ready to be occupied
- Class refers to the age, construction, and amenities of a building using the standard building classifications of A, B, or C
- Common areas may be exterior or interior space such as parking lots, park areas, lobbies, or restrooms available for non-exclusive use for all tenants and their customers.
- Estoppel certificate is a certified statement attesting that certain facts are true, often used by lenders to verify the party and rent clauses in a commercial lease
- Expense stop is the maximum amount a landlord will pay for operating expenses, with any overage passed through on a prorated basis to each tenant
- Floor plan shows a drawing of the building and the space being leased, and is often used in conjunction with a site plan
- Letter of intent (LOI) is a non-binding written document used to formally indicate a tenant’s or buyer’s interest in leasing or purchasing commercial real estate
- Rentable square feet is the total amount of square feet a tenant pays rent on and is calculated by adding the tenant’s usable square feet plus its pro-rata share of common area space
- Site plan is a drawing indicating the size and location of the building, common areas, and routes for building ingress and egress
- Trade fixtures are attached fixtures such as a restaurant hood vent, built-in coolers, or sink basins in a barbershop that the tenant may take when the lease ends
- UCC-1 or Universal Commercial Code, Form 1 is a standard legal form that provides public notice of a tenant’s personal property pledged as security
- Usable square feet is the amount of square footage for the tenant’s exclusive use
Understanding the language and terms of a commercial lease is key to making the best decision possible when renting office, retail, or industrial commercial real estate. Negotiating the best commercial lease terms for your operations can create a solid foundation that will help keep your business growing year after year.
