Renting a commercial property is one of the biggest decisions a business can make. Expanding into a new or larger building is a sign of growth and represents a significant step forward in any business’ timeline. However, terms and conditions are tricky and can have a significant impact on whether a company fails or succeeds. Once a contract for a commercial real estate property is signed, it’s too late to make changes.
Here are some of the most important things to know before renting commercial property space for a business.
Commercial vs. Residential Leases
Most people understand how residential renting works. But a surprising number of tenants and some CRE investors don’t know the difference between commercial and residential leases. Here are some of the most significant differences:
No standardized forms
A commercial lease to rent property doesn’t have a standardized form. Terms and conditions are negotiable and can differ from one tenant to the next, even in the same building.
Long-term and legally binding
Real estate commercial leases are long-term, usually for five years or more, and are legally binding. Landlords frequently ask for personal guarantees, which means tenants are ‘on the hook’ for rent payments even if the tenant’s company goes out of business.
Few consumer protection laws
All states have residential-landlord tenant laws. However, few consumer protection laws cover renting commercial property. For example, there are usually no limits to security deposit amounts or rent increases. Evictions for non-payment of rent or breach of contract can happen much faster for commercial space than renting a residential property.
Main Types of Commercial Real Estate Leases
With these basic terms in mind, let’s look at the three main types of commercial real estate leases:
Gross or full-service lease
With a gross lease, the tenant pays the same rent amount to the landlord every month. Gross or full-service leases include the tenant’s pro-rata share of expenses in the monthly payment. If services such as utilities or janitorial are excluded from the rent payment, the contract is called a ‘modified gross lease.’
Percentage leases occur most commonly with retail properties. Tenants pay a fixed lower base rent every month plus a percentage of the tenant’s gross sales over a certain amount. Theoretically, percentage leases give the landlord an incentive to promote the shopping center and keep the property in prime condition because it shares its tenants’ successes.
A net lease means a base rent amount plus additional charges for the landlord’s operating expenses for the building. Each ‘net’ represents an addition to the base rent:
- Single net lease (N): Base rent plus the tenant’s pro-rata share of property tax.
- Double net lease (NN): Base rent plus the tenant’s pro-rata share of property tax and building insurance.
- Triple net lease (NNN) : Base rent plus the tenant’s pro-rata share of property tax, building insurance, and common area maintenance costs (CAMs).
In addition to these net charges, tenants with a net lease may also pay for their utilities and building repairs. Net leases are often found in free-standing buildings such as fast food outlets or single-tenant property.
What to do Before Renting a Commercial Property
Here are seven of the most critical items to review and understand before acquiring a commercial property for rent:
- Read and understand the contract, and have an attorney review the terms and conditions rather than rely on the landlord’s leasing broker for an explanation.
- Negotiate the best commercial lease possible by hiring a commercial real estate broker who represents only the tenant.
- Understand how CAM charges work, including annual increases, expense stops, and how the pro-rata share of square footage is calculated.
- Ask the landlord to include assignment and sublease clauses. These dictate whether the contract can be reassigned to another tenant — part or all of the space to be leased to a subtenant — if the business doesn’t go as planned.
- Most landlords ask for business and personal guarantees with a commercial lease, so be sure to understand the potential risks and liabilities by consulting with a commercial real estate attorney.
- Try to obtain exclusivity for the property so that the landlord cannot rent to more than one tenant of the same business type.
- First right of refusal allows the tenant to have the first option on additional space for lease if it becomes available. The tenant is allowed to make or match an offer on the property if it is listed for sale.
Commercial Real Estate Lease Language
Language in a real estate commercial lease can be complicated, with terms and technical jargon foreign unless you use them every day. Here are some of the most common terms to expect when renting a commercial property:
Rent per square foot (PSF): Quoted per month or per year. A 1,500 SF office space renting for $18.50 PSF per year would cost $27,750 the first year, with the rent $2,312.50 per month.
CAM: Common area maintenance charges for expenses such as landscaping, janitorial, and parking lot cleaning are sometimes passed through to the tenant based on the pro-rata share of the property being rented.
Pro-rata share: Used to determine a tenant’s share of CAM charges. For example, if the 1,500 SF office above is part of a 20,000 SF office building, the tenant’s pro-rata share is 7.5% (1,500 SF / 20,000 SF).
Building classes: Building class can be A, B, or C and describes the condition, quality, and amenities in a commercial property. Classes differ from market to market, which means a Class A building in Nashville might be considered a Class B property in Los Angeles.
Tenant improvement allowance (TI): Cash allowance offered by the landlord to the tenant as an incentive to lease vacant space. TIs may be paid ‘upfront’, provided in the form of ‘free rent,’ or spread across the first year of the lease as a partial credit each month.
Fixturing period: The period of time when no rent is charged while the TIs are being completed. Tenants usually pay for the utilities and must have insurance, along with an executed lease.
Sublease: A commercial lease term that allows a tenant to lease all or part of the space to another tenant during the period of the existing lease. Tenants who sublease space are responsible for paying the landlord in full, even if the subtenant does not pay the tenant.
The Bottom Line
There are plenty of things to know before renting commercial property, and it’s important to arm yourself with as much knowledge as possible when beginning a rental search. Unlike renting a residential property, however, contracts governing commercial space for lease are almost always negotiable. It pays in more ways than one for a tenant to hire their own leasing broker, especially when the landlord pays the commission.