Nearly everyone has experience with residential leasing at some point in their life. Residential leases are typically straightforward, outlining the responsibilities of the landlord and the tenant, the stated rent due date and the inclusion or exclusion of utility costs within the stated rental amount. However, when it comes to commercial leasing, the process can be exponentially more complicated and complex. Here at Black Diamond Realty, we’ve interacted with some clients that have found themselves in tenuous circumstances due to signing or being presented a lease that they did not, or do not, fully understand. Many of these people are first time business owners, with no prior experience in commercial lease negotiation. One oversight can become the difference between growing a successful business and failure. It is absolutely imperative to understand the basics of a commercial lease to limit potential future pitfalls.
There are multiple lease structures with the commercial leasing world, but I will outline the four most common. The first type of lease structure is a Gross Lease. This type of lease is somewhat similar to a standard residential lease. The tenant is responsible for a total rental amount, with all real estate expenses being covered by the landlord. These expenses include real estate taxes, insurance, common area maintenance, and utilities. This makes things easy on the tenant, as they only have to worry about one amount per month.
The second type of lease structure is a Modified Gross Lease. This type of lease structure is similar to a gross lease, only the tenant is responsible for a portion of the expenses on top of the otherwise bundled rental rate. Instead of being a monthly fixed amount, these expenses are variable and usually consist of the building utilities, with the possible addition of the property taxes, insurance or common area maintenance charges.
The third type of lease structure is a Triple Net Lease. This type of lease structure relieves the landlord of all expenses related to the property excluding certain building repairs. Under this lease structure, the tenant is responsible for the utilities, real estate taxes, insurance, and common area maintenance charges.
The fourth type of lease structure is an Absolute Net Lease. This type of lease structure is usually reserved for credit tenants (Whole Foods, Wal-Mart, Macys, etc.) engaged in long-term lease agreements (10 or more years). Under this lease structure, the tenant is responsible for all expenses related to the property including all maintenance and repairs. This is the most favorable lease structure for a landlord, as they have very little responsibility during the life of the lease.
When looking for space, it is important to understand the lease structure being offered by the landlord. Space is usually advertised via the base rent amount per square foot per year. This is very different from residential leasing, which advertises a fixed monthly amount for the life of the lease. If a 1,000 square foot space is advertised at $12.00 per square foot (PSF), that equals to $12,000 a year or $1,000 a month in rent (1,000 SF X $12 = $12,000/12 months = $1,000). In commercial leasing transactions, where the tenant is additionally responsible for a portion of the real estate expenses, that additional amount is usually exhibited via its own per square foot amount. For example, if a tenant is responsible for roughly $2,000 in real estate taxes, the landlord would advertise the 1,000 square foot space at $12.00 PSF with $2.00 PSF in additional expenses for a total rental price of $14.00 PSF. This is important to remember, because this additional amount is the difference between paying $12,000 a year in rent, and $14,000 in rent, which can have an impact on a business’s bottom line at the end of the year. Depending on the lease structure (Gross, Modified Gross, Triple Net, or Absolute Net), this additional amount may be fixed or variable.
In addition to the financial aspects of the lease structure, it is equally important to understand the duties of the landlord and tenant. Repair and Maintenance (R&M) obligations are a critical component. Unlike a residential lease, under which the landlord must statutorily cause the premises to meet a minimum standard of habitability, the duties placed on landlords and tenants of commercial premises are different and often contractually based. Tenants have all R&M duties under Absolute Net leases, but tenant R&M duties often decrease when comparing a Triple Net Lease to a Modified Gross Lease and finally to a Gross Lease. Landlords are often responsible for capital, structural, and major mechanical items, while tenants are often responsible for day-to-day maintenance/cleaning and damages caused by the tenants or their customers; however, the details, boundaries, and amounts are often determined on a lease-by-lease basis. Thus, it is important to carefully review the repair and maintenance language and clarify, if necessary, each party’s responsibilities.
In addition to the core items described above, there are other important factors involved in the negotiation of commercial leases. It is always best to have a knowledgeable commercial real estate associate working with you throughout the negotiation process, and a sound real estate lawyer to look over all the lease documents before signing. If you’re ever in the market to lease industrial, retail or office space, give Black Diamond Realty a call at 304-413-4350. We can help to make sure that the lease you’re signing is fair and equitable.