If you’re just getting your startup going, or even if you’ve been in business for a while, learning real estate terminology can be a big hurdle. Pair these terms with anything resembling legalese, and we wouldn’t blame you if your eyes glazed over. However, it’s important to understand the terms and provisions commonly found in commercial leases in order to make the best financial decisions for your company. Acquaint yourself with these standard commercial lease provisions to ensure that your next lease agreement works for you.
Types of Commercial Leases
- Fixed Lease: a lease that provides for a fixed amount of rent over a fixed rental period (term). While these types of leases usually seem the least threatening for small business tenants, there is a downside to a fixed lease: Upon lease renewal, the landlord may choose to raise rent sharply, which could be detrimental if your business is doing well and would suffer from relocating.
- Gross Lease: the most traditional type of lease wherein the tenant pays rent and the landlord takes care of taxes, insurance, and maintenance expenses related to the property. Gross leases often contain escalation clauses that allow the amount of rent to be adjusted (usually on an annual basis) to offset increased expenses.
- Net Lease: a lease that transfers some or all of typical landlord expenses to the tenant, depending on the degree of the lease. With a single net lease, the tenant pays rent plus taxes relating to the tenant’s portion of the property. Under a double net lease, the tenant also pays a portion of insurance premiums. Finally, with a triple net lease (often favored by larger businesses), the tenant pays all charges payable under a double net lease, plus maintenance expenses.
- Percentage Lease: a lease in which your landlord shares in your good (or bad) fortune. The lease provides for a fixed amount of rent, plus an additional amount that is set as a percentage of your gross receipts or sales.
- Step Lease: a lease that provides for set rent increases to take effect at stated times. Assuming that increases are in line with historical increases in your area, step leases provide you with the peace of mind of knowing what your rental amounts will be for a longer time period while giving the landlord some protection against rising costs.
Commercial Lease Terms and Clauses
- Competition: an important consideration in the case of retail spaces, such as a store in a shopping mall. Consider pushing for restrictions on your landlord’s right to lease nearby space to businesses similar to your business.
- Destruction or Condemnation: determines the actions taken should the facility be partially or totally destroyed, including whether the landlord is required to rebuild, whether rent will be abated, and whether you can terminate your lease obligations. This provision will also specify what happens if the facility is taken by eminent domain.
- Escalation Clause: a clause that provides for increases in rent over a specified time period. The escalations can be fixed or determined with reference to an outside factor, such as increases in your landlord’s operating costs, increases in a cost index (such as the consumer price index), or increases in your gross receipts or sales.
- Improvements and Modifications: your rights to make improvements or modifications to the facility so that it better suits your needs.
- Insurance and Liability: the responsibility for casualty and liability insurance, as well as how much coverage is required. This term may also determine under what circumstances you and your landlord will excuse each other for property damages or personal injuries.
- Landlord’s Solvency: a useful provision that spells out your rights as a tenant if your landlord’s mortgage company forecloses on the leased premises.
- Lease Term: how long the lease will be in effect. Depending on the initial lease term, you could benefit by negotiating the inclusion of a renewal option in your initial agreement that would entitle you to renew later for a specified period and a specified rent.
- Maintenance: who is required to maintain which portions of the building and land. If you are responsible, the lease should say whether you can choose the service providers or whether they have to be approved by your landlord.
- Purchase Option: your right or obligation to purchase the facility at the end of the lease term. This provision should specify an option price or range, as well as how and when the option may be exercised.
- Renewal Option: your rights to renew the lease when it expires. If you are allowed that option, the provision also specifies the amount of rent to be paid for the renewal lease term. A renewal option can give your business protection against an unreasonably large rent increase when your first lease term expires.
- Rental Rate: the rental amount and when it must be paid. Most leases also include late payment provisions that impose additional charges if you fail to pay the rent by its due date or within a specified grace period. If your business experiences seasonal or irregular sales activity, ask for a flexible rental rate that corresponds to the changes in your cash flow.
- Subletting: whether, and under what conditions, you are entitled to sublease the premises to another. Remember, if you sublet the property, you are usually still liable for paying the rent if the subletting tenant does not pay.
- Taxes: specifies the party responsible for the real property taxes.
- Tenant “Going Dark” Rights: a consideration specifically for small tenants in a shopping center dominated by one major tenant upon which your traffic depends. If this major tenant goes out of business or does not renew its lease (known as “going dark”), this provision entitles you to a large rent reduction or gives you the right to close your store.
- Zoning and Land Use Restrictions: the zoning or other restrictions that apply to the building.
Still need help? Your NAI Beverly-Hanks Commercial Associate is available to help. Contact our expert commercial team for help negotiating the terms of your next commercial lease.