By Kellye Fox
So, you’re a landlord who has been renting apartments for five years? You’ve established yourself in residential leasing and are ready to move on to bigger and better properties. Why not try the commercial sector with commercial leasing? In this article, I will address the differences between a residential and commercial lease, the various types of commercial leases and the terms to remember when drafting your lease. To refresh your memory, commercial property is classified as business property, retail strip centers, strip malls, office space, shopping centers, hotels, theaters and parking facilities, to name a few.
The steps to purchasing a commercial property are similar to residential, in that it’s advisable to locate a real estate agent who is well versed in commercial real estate. It is important to know what the space is zoned for, as this will determine what type of businesses can occupy the space. For example, not all commercial space can be used by restaurants. With the help of a qualified agent, refer to the deed and seek legal counsel to identify this information.
As with typical leases, there is a lessor and lessee. The lessor, or the landlord, is the owner of the real estate and the lessee is the tenant. Not all parties of the lease are one person. Some are LLC’s, corporations, partnerships, co-tenants or co-owners. It’s important to identify exactly who owns or is leasing the property for legalities. A commercial lease is a rental agreement that allows the lessee to legally occupy a given business space from the lessor for a monthly fee. The lessee does not build equity in the property, have an option to purchase the space at the end of the lease term, or pay principal and interest.
Residential vs. Commercial
Like residential leases, a commercial lease can be negotiated. Since the space of most businesses will likely need to be changed, the terms will need to be negotiated. Unlike residential leases, these types of leases reach from 10-50 pages and are extremely complicated with their jargon, addendums, terms and clauses. Generally, a commercial lease protects both parties by documenting all of the agreed terms of the occupancy, responsibilities, obligations and facts in writing. In many instances, the lease is drafted by an attorney or the landlord’s solicitor, who has the landlord’s best interest covered. There is no “standard” commercial lease used for this industry. Instead, each lease caters specifically to each circumstance. As the landlord, you should take advantage of this when drafting the lease. Most tenants have no idea what commercial leasing entails and do not take the time to seek an attorney, nor read the lease carefully. While I am not encouraging taking advantage of your tenants, this is a bi-lateral, legally-binding business arrangement and your goal is to make a profit above your expenses. Any unscrupulous activity will be documented and shed an ugly light in terms of your reputation in the commercial sector.
Additionally, depending on the commercial rental market, negotiating the terms of the lease can take from several weeks to several months. Thus, it is imperative for a lessor and lessee to agree to the terms prior to signing the lease. You don’t want your tenant to find a loophole and somehow get out of their lease, leaving you with a vacant spot and no income. It is wise to take preventative measures and anticipate any future problems.
It should also be noted that other than a few basic provisions applicable to retail leases, the Government has chosen not to regulate or control the terms of commercial leases. Thus, there are no consumer protection laws that rule commercial leases (i.e no caps on deposits or rules protecting tenant privacy).
Types of Commercial Leases
So, now you have decided to purchase commercial space and locate tenants. What type of lease will you have them sign? As a tenant, their commercial loan terms are based on what type of lease they sign. So, be sure to seek legal advice and to think about what type lease makes most sense to you. Here are some of the most common leases to consider:
- Gross Lease – rent includes utilities, repairs, taxes and insurance (much like a residential lease).
- Net Lease - fixed rent plus a portion of the landlord’s operating expenses, including maintenance, building insurance, taxes and utilities.
- Double Net Lease – rent, plus taxes and insurance (lessor pays for maintenance).
- Triple Net Lease – rent, plus property taxes, insurance and maintenance.
- Percentage Lease – rent is determined by a portion of the lessee’s net income or gross profits (typically used for large retail operations).
Drafting a Lease
As with any new business venture, you should establish your team of advisors, including an attorney and property manager. Locate an attorney who specializes in real estate law. Their roles and responsibilities should be defined early on as to avoid any confusion. For example, who will be the negotiator? You or the property manager? After that, issues such as rent, maintenance, improvements and expenses need to be discussed and defined when working with the potential tenant. A letter of intent is optional to secure an offer to lease.
As the owner of the commercial space, it’s important to draft the lease in your best interest and you must decide on several factors – type of lease (Gross, Triple Net, etc), length of lease (short-term or long-term), rental amount, etc. While short-term leasing may give a business more flexibility, that business is not obligated to renew at the end of the term. In turn, you may lose business. In that case, subletting may be a consideration to recoup costs. On a positive note, if you foresee that a business in your building or complex will be successful and profitable, you may want to include an increase in rental payments when they come up for renewal.
When a lessee is interested in renting a space in your building, there are several factors that they will consider:
§ Parties to the contract.
§ Rental amount (as well as security deposit and circumstances and method of return), term, extension, method of computation, frequency and allowable increases.
§ Type of Lease – does the rent cover utilities, taxes and maintenance or charged separately?
§ Length of lease and whether there’s an option to renew.
§ Insurance.
§ Permitted use and access.
§ Location, actual space rented, common areas that are included.
§ Is special zoning required for the business?
§ Specifications for signs and their placement.
§ Improvements – who will pay and own them upon termination of lease?
§ Maintenance and repair of premises.
§ Whether subletting or assignment is allowed.
§ How disputes are handled (court, mediation or arbitration).
§ Equipment leasing.
§ Responsibility of HVAC system (heating-ventilation-air conditioning).
§ Federal, state and local requirements (i.e. Occupational Safety and Health Administration), hazardous material disclosure or the ADA (Americans with Disabilities Act) compliance.
As a lessor, you’re responsible for calculating various costs including Common Area Maintenance (CAM) and taxes. Luckily, there are several real estate software packages that can assist in generating monthly reports, termination dates and options to renew documents. It’s critical to your bottom line to invest in an accounting system and/or leasing software to expedite your outsourcing fees and staff.
Kellye Fox is a Realtor® with Property Consultants Realty in Chicago. She can be reached via e-mail at kfox@propertyconsultants.com or at 312-492-3234.
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