What Is a Commercial Lease & How Does It Work?

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At first glance, a commercial lease may seem intimidating. 

Leases for commercial spaces can run 40-50 pages long, stuffed with unfamiliar industry jargon. Plus, they are often written by the landlord for the benefit of the landlord. 

But the good news is that commercial leases are almost always negotiable.

In this article, we’ll discuss the main parts of a commercial lease, the different types of contracts, how lease rates are quoted, and some clauses to watch out for when negotiating a lease for commercial space.

Main components of a commercial lease agreement

All types of commercial lease agreements include the same general “boilerplate” components:

Parties

This clause identifies the tenant (lessee) and the landlord (lessor) by name, including contact information and a mailing address for rent payment and notice purposes.

Property

This section includes the building address and description of the unit being leased, including floorplans and a site plan of the entire property.

Use

Describes for what purpose the tenant is leasing the space, the type of business, and if the tenant has the right to an “exclusive use” that prohibits other tenants in similar industries from leasing space within the same building.

Term

Term specifies the start and end date of the lease agreement. The term also includes when occupancy (physical possession) by the tenant takes place, and if there are options to renew the lease.

Type

Defines the commercial lease as gross or full-service, modified gross, or net lease.

Rate

This defines the lease cost per square foot, the details of any potential increases in lease rate, and what items are included in the rate.

Deposit

Amount of security deposit collected from the tenant, how long the deposit will stay with the landlord, and whether interest accrues on the deposit. The clause also defines what deductions the landlord can make from the security deposit if the tenant defaults on one or more terms of the lease.

Improvements

Describes the tenant improvements (TIs) to be made to the space, who pays for them and how, and when the work will be completed.

Maintenance

Discusses which items require maintenance by the tenant or landlord, and any limits that apply to the amount paid by either party.

Common Areas

Identifies common areas shared by all tenants, such as parking areas, sidewalks, lobbies, elevators, and public restrooms, and what may or may not occur in a common area without receiving permission from the landlord.

Signage

Lists restrictions and permissions for signage such as exterior monument signs, a directory sign in the lobby, and how far in advance of the lease termination date the landlord may install a “for lease” sign outside of the tenant’s space.

Insurance

This section covers what insurance policies the tenant is required to obtain before taking possession of the space, including liability and business interruption insurance.

Landlord Entry

The landlord is required to give the tenant a specified amount of notice before entering the space, and this section outlines any exceptions made for routine maintenance or emergencies such as a plumbing line break or roof leak.

Subletting

Allows or prohibits the tenant from subletting (leasing to another party) any amount of the leasing space, landlord notification and approval of a tenant sublease, and any additional terms and conditions of a sublease.

Default or Breach

Describes what happens if the landlord or tenant breaches one or more terms and conditions of the lease, actions that may cause a breach of contract and if either party may terminate the lease early due to default or breach by the other party.

Addendum

An addendum can modify or amend the boilerplate language of a commercial lease to customize the lease terms and conditions based on the specific situation of the tenant and landlord. For example, a tenant may require additional parking spaces or have the right to terminate the lease early without liability.

Types of commercial leases

Commercial real estate leases fall into three main categories:

Gross lease or full-service lease

Under a full-service or gross lease, a tenant pays a set rate each month. In contrast, the landlord pays for all of the property operating expenses such as utilities, internet service, building, and common area maintenance, taxes, and insurance.

Another way to think of a gross lease is that it gives the tenant an “out the door” price for the leased space. In other words, if the rate for a 10,000 square foot space is $24 per square foot per year ($240,000 annually), the monthly check the tenant writes the landlord will always be $20,000 ($240,000 / 12 months).

A gross lease works for many tenants because it simplifies budgeting and avoids unexpected repair fees. On the other hand, gross rents make it difficult for a landlord to pass along expenses for higher-than-normal electric bills or capital repair costs such as a new roof or parking lot repaving.

One typical example of a gross lease is a lease for coworking space. In a shared office space setup, the tenant pays one fixed monthly fee to use the area – although there may be “à la carte” charges for items such as extra hours for meeting room space.

Modified gross lease

As the name suggests, this type of lease “modifies” or changes the terms and conditions of a gross lease. Tenants and their brokers should both understand what modifications are being made to the contract.

Tenants with a modified gross lease pay a fixed rate per square foot and also pay for some charges directly, such as utilities or janitorial. If a building doesn’t have separate utility meters for each suite, a landlord may bill the tenant for its share of services under a lease that is modified gross.

As an example, let’s look at a modified gross lease for a 10,000 SF space in a building that has a total of 100,000 square feet. The annual lease rate is $20 PSF, and the tenant pays for utilities and janitorial:

  • Annual rent: 10,000 SF x $20 PSF = $200,000 per year
  • Annual utilities and janitorial: $30,000 per year or $3 PSF
  • Total lease rate: $23 PSF per year ($20 PSF annual rent + $3 utilities and janitorial), or $230,000 per year, or about $19,167 per month

Based on this example, the tenant saves over $800 per month compared to the full-service gross lease in the previous section. However, if utility bills increase due to an unseasonably hot summer or cold winter, those savings could quickly disappear.

Net leases

Under a net lease, a tenant pays a fixed amount as “base rent” plus a pro-rata share of property taxes, building insurance, and common area maintenance (CAM). 

The items that are paid by the tenant – or “passed through” to the tenant from the landlord – depend on the type of net lease the tenant has:

  • Single net lease: base rent + property taxes
  • Double net (NN) lease: base rent + property taxes + building insurance
  • Triple net (NNN) lease: base rent + property taxes + building insurance + common area maintenance

With a net lease, tenants also pay directly for any additional services such as utilities and janitorial.

Now let’s look at how a triple net (NNN) lease is structured. 

In this example, a 10,000 SF space is being leased in a 100,000 square foot building at a base rent of $16 PSF per year. Building property taxes are $100,000 ($1 PSF) per year, building insurance is $20,000 ($0.20 PSF) per year, and CAM (common area maintenance) is $300,000 ($3 PSF) per year:

  • Base rent: $16 PSF x 10,000 SF = $160,000 per year
  • Property tax: $1 PSF x 10,000 SF = $10,000 per year
  • Building insurance: $0.20 PSF x 10,000 SF = $2,000 per year
  • CAM: $3 PSF x 10,000 SF = $30,000 per year
  • Total NNN lease rent paid: $160,000 base rent + $10,000 property tax + $2,000 building insurance + $30,000 CAM = $202,000 or $20.20 PSF

Net leases can be good for the landlord, and potentially good or bad for the tenant. Landlords use net leases to pass through building owning and operating expenses to the tenant.

Tenants with net leases may benefit from paying a lower overall lease rate, but also run the risk of total rent costs increasing if property taxes, building insurance, and repair expenses rise. 

Often, a single-tenant building such as a bank branch or fast food outlet is leased on a triple net basis to a tenant. This allows the tenant to have complete control over how the building operates while providing the landlord with a steady stream of rental income with little or no property management responsibilities. 

Remember: definitions may vary

Keep in mind that there may be regional or “market custom” differences between the names used for lease types, similar to the way that lease rates vary from market to market. 

For example, in one market, it may be customary not to include electric bills in a gross lease – but still call the lease “gross” – while in another part of the country, this same situation would be a modified gross lease.

As such, leasing brokers need to verify the exact inclusions of a rental rate the tenant pays, regardless of what the lease is called.

How commercial lease rates are quoted

Three main factors determine the rate a tenant pays to lease a space:

  • Size of the space – or suite – being leased
  • Services provided that are included in the lease payment
  • Amenities, features, and class of the building housing the space

Rate per square foot

Lease rates may be quoted on a per-square-foot-basis per month or per year. For example, if a 10,000 square foot (SF) suite has an annual rent of $240,000 the rate per square foot (PSF) would be:

  • $24 PSF on an annual basis = $240,000 / 10,000 SF
  • $2 PSF on a monthly basis = $240,000 / 12 months = $20,000 per month / 10,000 SF

In both cases, the annual leasing expense to the tenant is the same; it is just expressed differently. 

Market custom – and sometimes the asset class of the space – determines if a commercial lease rate is quoted on a monthly or annual square foot rate. Leasing brokers may work in a market where it is customary to quote office and retail lease rates at a yearly square foot rate, but for rates on industrial space to be quoted as a monthly rate PSF.

Fixed monthly fee

Sometimes tenants and their leasing brokers will find space quoted at a flat monthly fee instead of per square foot. 

Often coworking or shared office space is priced at a fixed monthly fee. That’s because the tenant is paying for the space and accompanying services, such as lease term flexibility and the ability to use office space in different buildings operated by the same coworking firm.

It’s always a good idea for users to break down the fee paid to a rate per square foot. This way, tenants and brokers can use the same metric to compare “apples to apples.” 

For example, if the market rate for office space is $24 PSF per year, but the fixed monthly fee for a particular unit ends up being $12 PSF per year, users should ask why there is such a big difference in the per-square-foot rate.

Other important leasing terms, conditions and clauses

Commercial leases are customized to the unique needs of each tenant and property owner. As such, no two lease agreements are ever the same, sometimes even within the same building.

Here are some other essential leasing terms, conditions, and clauses to consider when negotiating a lease:

  • ADA compliance requires the landlord or tenant to make improvements to the suite to comply with the Americans With Disabilities Act (ADA)
  • Attorney fees and whether losing party pays
  • Bankruptcy by landlord or tenant
  • Dispute process and whether mediation is required before filing a lawsuit
  • Escalations allow the landlord to increase the base rent by an agreed-to fixed amount of percentage, usually once a year
  • Expansion clause gives the tenant first right of refusal to lease additional space that becomes available in the property
  • Foreclosure process if landlord defaults on property loan
  • Gross-up of a full-service lease where landlord charges extra if operating expenses exceed a certain annual amount
  • Load factor is a ratio the compares the amount of rentable square feet to usable square feet
  • Percentage lease is sometimes found in retail property and requires the tenant to pay a base rent plus a percentage of gross monthly sales over a certain amount
  • Relocation clause allows the landlord to relocate the tenant to a different suite at the landlord’s expense
  • Renewal or extension clauses give the tenant the right to renew the existing lease at a previously agreed to rate or the current “at the market” rate
  • Rent abatement or “free rent” is used by landlords as a tenant incentive. This may be a fixed dollar amount, a specific amount of time where rent is waived, or a credit that is apportioned across the entire lease term
  • Rentable square feet and how much space is unusable due to building core items like stairwells and elevators
  • Security arrangements and after-hours access
  • Turnkey means that a unit is move-in ready and that all wiring and plumbing, and cosmetic items such as painting and flooring, are already in place
  • Useable square feet are the actual amount of space a tenant can occupy

Key things to remember about a commercial lease

Nearly every part of a commercial lease is subject to negotiation. It all depends on the condition of the local market, the strength of the tenant, and the motivation of the landlord.

  • Main parts of a commercial lease include beginning and ending date, type of contract, base rent and escalations, common area maintenance charges, and renewal and relocation clauses
  • There are three main types of commercial leases: full-service or gross, modified gross, and net
  • Net leases can be single net, double net, or triple net
  • Lease rates may be quoted as a fixed fee, at a monthly price per square foot, or an annual rate per square foot
  • Lease rate quotes may vary from market to market
  • Names can be misleading, so tenants and leasing brokers should always ask what is included in the lease rate

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Shanti Ryle
Shanti Ryle

Content Marketing Manager

Shanti leads CREXi's content marketing strategies with 7+ years of content development experience, creating everything from blog posts to award-winning podcasts. Previously, she worked on content teams at Snapchat, Weedmaps, and HopSkipDrive as well as developed copy, articles, and media for freelance publications.

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