The Top Commercial Real Estate Leasing Basics
Smart entrepreneurs know:
The right space is essential to the success of any company.
Whether you are looking to lease office space or purchase an investment property where your company can live, there are a variety of things you absolutely have to consider.
For most businesses, facility cost is the largest expense outside of payroll or inventory. But it doesn’t have to be your largest headache. As long as you educate yourself and compare all of your options, you can find a good value in most markets.
However, there will always be one major obstacle that stands in your way:
Commercial leases are not boilerplate agreements. Yes, many landlords or brokers will tell you “it is a standard or boilerplate agreement”. The implication being “many people have read and signed it so you can too.” Or “let’s just leave those pesky, expensive attorneys out of it”. While it really might be a template that many have signed unaltered, it does not make it less meaningful or binding.
This makes it extremely important that you read everything in your leasing agreement. But you need to start by knowing what you’re actually looking for.
Anyone in the market for needs to understand the full list of our commercial real estate leasing basics before they ever start comparing properties.
First things first:
You need to know what you’re getting into.
Commercial real estate leases have little in common with residential real estate leases. It starts with the level of negotiability. This has a lot to do with the lack of true standard forms or agreements mentioned earlier.
Businesses often need special terms in the contract or features in the space. Landlords are often eager to meet halfway in an attempt to fill their spaces with renters.
However, don’t expect the same treatment you’ve received with residential leases.
First, there is less consumer protection—meaning there are no limits on security deposits or privacy protection laws. Second, commercial leases are long-term, legally binding, and difficult to get out of or change.
This makes it all the more important to make sure you find the right lease on the right space.
The space your business will occupy is known as the “Demised Premises”.
It’s important that your commercial lease agreement make it clear what space you are renting. Don’t take for granted that the premises described in the lease agreement will be the same one you are expecting.
Your lease should include both a street address and floor plan (and in some cases a site plan). This is what essentially defines the premises you are renting. It’s extremely important to make sure you understand exactly what space you’re being charged for and what does and does not come with it.
For starters, you need to know the difference between Rentable Square Feet (RSF) and Usable Square Feet (USF) in your leasing agreement.
Your rent will be based on the RSF, which includes common areas such as lobbies, stairwells, elevators, and bathrooms. USF is the space that is exclusive to your business and available for your operations.
Perhaps the most fundamental thing you need to know about your lease agreement is which kind it is—or better yet, what each variety means for you as a business owner.
There really is a lot to be said about the different types of commercial leases, but most are either “gross”, “triple net”, or some shade of the two (“modified gross”). The distinction is really all about real estate taxes, utilities, insurance, janitorial costs, and maintenance expenses—in a nutshell, who pays for what.
Gross (or full service) commercial leases are all-inclusive. This means that the rent covers your portion of these extra expenses. Triple net (or NNN) leases leave a share of taxes, insurance, and maintenance to the tenant.
Keep in mind that certain items like telecom and internet are almost never included. Furthermore, internet availability is not guaranteed by the landlord.
The type of commercial real estate lease offered is a vital when comparing multiple locations.
The base rate is simply the price of rent over the term of the lease.
A legitimate commercial lease should clearly define both rental rates and any future “escalations” in price. Generally, this is conveyed with a rental chart of some kind which illustrates the annual rental rate over time.
In many leases, the yearly rate increases by a flat percentage (referred to as the “escalation rate”) such as 2.5%. In others, it is determined based on some formula involving an external variable such as the consumer price index, a.k.a. the natural breakpoint.
For some retail companies, the rent even includes a percentage of the tenant’s yearly sales.
Many prospective renters want to skip directly to this point in the conversation. But the fact of the matter is that base rate is largely dependent on the other expense responsibilities you’ll find highlighted here.
Before you start trying to push your price down, there is still a lot more to consider.
Commercial leases should define who is responsible for repairs both on the premises and the property at-large, aka “common areas”.
This includes plumbing and electrical work, certainly. But keep your eye out especially for information regarding HVAC repair. This is an area where disputes tend to arise, especially in geographies where constant climate control is warranted.
When looking at triple net agreements, you’ll want to pay extra attention to “common area maintenance” (or CAM) expenses. This is the part of agreement regarding what portion of these costs you will be required to pay.
It’s important to review this section with extra care so that you have a full understanding of your share of costs for security, ice removal, building management fees, and any other features of the Premises you rent along with its broader property.
Be sure you sort out the the question of payment and who is responsible for making sure the repairs are completed on what time frame and to what specification.
If the space you’re looking at can’t accommodate your company, you’re wasting your time.
If basic space needs are met (or nearly met), lease negotiations give you the opportunity to lobby for what your company specifically needs.
Many landlords are more than willing to fund modifications to attract your company to their property. Called “build-out” commonly or “tenant improvements” in commercial real estate, it’s vital that the lease contract spells out exactly what will be done, who will pay for it, and when it will be completed.
If the landlord agrees to pay for something, the “allowance” amount or “scope of work”, should be spelled out in the contract as well. Tenants want “turnkey”. Landlords want “allowance”.
Tip: Any promises for improvements must be in writing! Items discussed during a walk through, but not specifically included in the landlord’s scope of work will always fall to the tenant.
In addition, the lease agreement should always contain information about how the space is to be used. Office buildings offer general use and little else, while retail locations often get much more specific. Consider signage rights and parking availability and allocation as well.
It is almost always the responsibility of the tenant or buyer to confirm that its use of a space conforms to government zoning and that the build out of the premises accommodates tenants needs as defined by various governing authorities.
There are other provisions that might be important to your particular business. One of the most common is called an “exclusive”, which ensures that no other business of the same type can operate in the same shopping center, business park, or (less commonly) office tower.
It can be fairly difficult to find a space that fits your business and your budget. But if you have the proper leverage, you are more likely to find landlords who are willing to accommodate your needs.
Understanding what affects your leverage at the negotiating table is a crucial part of commercial lease negotiation.
Specific demands you’ve made in areas aforementioned have the potential to reduce your ability to apply leverage elsewhere. Particularly in a landlord’s market, owners need to follow the path of least financial or logistical resistance.
Most new companies especially, come to the table with no track record and minimal resources. Therefore they must prioritize carefully.
The History (and Projected Future) of Your Business
Landlords are more willing to go the extra distance to secure tenants who 1) they believe they can rely on or 2) boost the value of their property.
The first group of tenants includes companies that have been around for a long time as well as those in industries that tend to do well in the area. The second group might include brands that the landlord sees as prestigious or as an attractor of other tenants or symbiotic consumer traffic.
If you’re a startup, be ready to make some concessions in order to get the space you want.
The Status of the Property
Don’t discount location or state of repair when it comes to real estate of any kind.
There are all types of property quirks or flaws that make landlords more desperate for tenants. The key is knowing enough to uncover them.
Obviously, you can look into a property’s history. You can see for yourself the state of the facilities (a.k.a. deferred maintenance). You can analyze the location using various software and research tools and even talk to current tenants. Finding a landlord whose needs mesh with yours gives you the best type of leverage.
Also, coming to the table as a “single user” tenant who wants to occupy an entire structure will almost always create a stronger negotiating position.
One of the most direct ways to increase your leverage in commercial lease negotiations is to sign a longer lease.
Landlords are always more willing to work with tenants who are committing for the long haul. However, be wary not to sign a lease that might potentially stagnate your business. Also, improvement costs as a proportion of base rent diminish as the lease term lengthens.
For most startups, the ideal is a short term lease with opportunities for renewal. Just know that you can expect higher rent, decreased allowances, and a lower overall chance of success.
Probably the most volatile of all factors that affect your negotiating leverage is the climate of the market you’re in.
Those in the industry often describe a market as a “tenant’s market” or a “landlord’s market”. Each moniker describes who is favored.
In a tenant’s market, landlords are generally anxious (or even desperate) for clients. In a landlord’s market, they feel much more comfortable with a “take it or leave it” stance. This makes current market conditions one of the most important things to understand when marketing for a lease.
Large metro areas like Atlanta, often have a wide disparity in conditions across different “submarkets” of the city. Effective evaluation of this context substantially increases your chances of finding the best deal.
You’ve probably already noticed, but there is a lot to take into account here.
And to be quite honest, all of this is just the tip of the iceberg. Commercial leasing is quite nuanced. There are still issues like sublease rights, termination procedures, expansion, how disputes are handled, and more.
For the vast majority of companies, tenant representation is critical. Having a tenant broker examine your lease agreement beforehand can make all of the difference in the world.
First, they deal with leasing agreements frequently. Considering the complexity and lack of regulation, a commercial lease is something you want a broker, and their favorite CRE attorney, to take a look at. This is true whether this is your first lease or your fiftieth.
Second, having an advisor by your side who has experience in the industry and area can help you identify how best to negotiate with potential landlords.
And finally, partnering with a broker who is familiar with and understands your local market will allow you to leverage that broker’s professional network to find a better match. You’ll also have a better chance of finding an attorney experienced in commercial leasing, if you need one.
Whatever your commercial leasing needs, it’s critical that you have a full understanding of what you’re getting yourself into. Only then can you identify which property and deal features are valuable to you.
Armed with that information, you can negotiate from a position of knowledge. And by now you must know, this is absolutely critical. It’s really the only way you can be sure of what you’re getting.
Remember to be wary of every lease offer you take a look at. Make sure you fully understand the terms and don’t disregard a single letter of the “fine print”. There are no “boiler plate” agreements. Your lease can absolutely make or break you.
In our experience, the best way to guarantee you end up with a lease that is suitable for your business is to seek professional representation. Whether you hire them, or not, it is up to you.
As experienced investors with decades in the industry, Atlanta Leasing and Investment is perfectly suited to help business owners with this critical decision. Whether you need help comparing offers, determining your needs, or negotiating for the best terms don’t hesitate to contact us today.
I’m thinking about getting into the commercial restate market. I will use these tips during my process. Thank you!
Nicole, thanks for reading. I’m glad you enjoyed the post!