Typical Commercial Lease Terms That Everyone Should Know
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During your search for commercial space, I’m sure that you’ve come across a lot of commercial
real estate jargon - but you need not worry! You don’t have to know everything.
This video will cover the basics of commercial leases including common lease structures,
important lease clauses, and the most common delivery conditions of commercial leases.
By the end of, you won’t know everything about commercial leases, but you’ll know
enough to be dangerous.
Lease Structures ________________
Commercial leases can be structured in a variety of ways, depending on the type of property,
type of business, and number of tenants. Here are a few of the most common structures.
Triple Net (NNN) A triple net lease, or a net lease, is one
of the most common lease structures. It requires the tenant to pay base rent along with the
three nets which are: * Property taxes
* Building insurance * Common area maintenance (CAM)
With triple net leases, the tenant incurs all expenses related to the property. But
the landlord is not off the hook! They are still responsible for maintaining the structural
components (structural walls, foundation, and roof) of the building.
The only time the landlord is completely free of responsibilities is when the tenant has
an absolute triple net lease – the tenant is responsible for the structural components
of the building too. To calculate rent for a NNN lease, you take
the estimated annual expenses and add that number to the price per square foot multiplied
by the rentable square footage of the space. Full-Service Gross (FSG)
A full-service gross lease, or full-service lease, requires the tenant to pay a base rent
while the landlord incurs all expenses related to the property.
Sounds great, doesn’t it? It can be great considering that the tenant knows exactly
what they’re paying each month - but it can also be a double-edged sword.
The property owner will probably significantly increase the base rent of the space with a
full-service gross lease as a means of risk mitigation for the owner - they want to be
as monetarily insulated as possible from unexpected expenses.
To calculate the rent for a FSG lease, you simply multiply the price per square foot
by the square footage of the space. Modified Gross (MG)
﻿ A modified gross lease requires the tenant
to pay a base rent along with only some of the operating expenses.
For example, a group wants to open an art gallery in a space that you have for lease.
You know that the electric bill will be significantly high, so create a modified gross lease where
the group pays monthly rent along with the electric bill.
Calculating the rent for a MG lease is almost the same calculation for finding full-service
gross rent; you multiply the price per square foot by the square footage of the space and
add this number to the amount of the expense(s) that you will incur in addition to rent.
Lease Clauses ________________
There are a myriad of clauses in a commercial lease. While it is important that you have
your lawyer review your lease, you should not be totally green to commercial leases.
Here are a few important clauses to keep in mind.
Sublease Clause﻿ Subleasing is where a tenant leases unused
space in their lease agreement to another tenant. The tenant’s lease agreement with
the subtenant is independent of the lease agreement between the tenant and the landlord.
Often referred to as the right to sublet clause, the sublease clause states that the tenant
does not have permission to lease a portion of space in their lease agreement to another
tenant unless consent is given by the landlord. Have your attorney review your lease - some
landlords will charge a sublease fee! This clause is important because any additional
space that you do not use, but is included in your lease could provide you with additional
income. Exclusive Right
The exclusive right clause or exclusivity clause, often found in retail leases but can
be seen in any industry, gives the tenant the right to be the only business that sells
a certain product or provides a specific service. For example, if you decide to open a nail
salon in a prominent strip mall, you wouldn’t want there to be another nail salon.
Why? Because they are a competing business and
have the potential to take some of your customers. Go for that exclusive.
Rent Escalation When leasing a space, your rent can increase
on a yearly basis or during any renewal options – this is what the rent escalation clause
covers. The rent escalation clause explains how much
of an increase in rent a tenant will be subject to. For example, a landlord my state that
there will be a 2% annual increase in rent. Or it may be that the rent increases by 5%
every two years – every lease is different. The rent escalation clause is one of the most
important clauses because in the long run, those annual 2% increases can greatly affect
your overall costs of tenancy.
Delivery Conditions ________________
Commercial spaces can be delivered in a variety of conditions.
Sometimes you may lease a space that is basically move-in ready, whereas you can also have a
space that its nothing more than the skeleton of the building.
Let’s dive into a few of the most common delivery conditions for commercial leases.
Vanilla Shell (Warm Shell) A vanilla shell lease, or whitebox condition,
can be one of the sweetest deals you get. Build out costs for vanilla leases are what
makes them so desirable – you spend the least amount, if any, during the build-out
of a vanilla shell lease compared to any other delivery condition.
Your costs for build-out mostly reflect the cost of your tenant-specific amenities.
Here are the amenities you can expect in a vanilla shell lease:
* Finished ceiling or drop ceiling * Finished restrooms
* HVAC & ductwork * Lighting
* Elevators But this comes with a cost. You should expect
a higher base rent since the property is being delivered in almost move-in ready condition.
Cold Dark Shell﻿ Cold dark shells are exactly what they sound
like. You can expect the spaces to be down to the studs of the building – it’s essentially
the skeleton of a building. A cold dark shell lease DOES NOT contain the
following amenities: * HVAC
* Electrical * Plumbing
* Elevators But why would you want a cold dark shell lease?
Aren’t the build-out costs going to be high? Yes, cold dark shell build-out costs are higher
than any other delivery conditions, but there is an incentive; the landlord generally offers
a lower rent and a higher tenant improvement allowance (TIA) since the build-out costs
will be high for the tenant. Second-Generation
Second-generation spaces are the hand-me-downs of commercial real estate. What makes second-generation
leases attractive is that it could require little to no build-out costs, depending on
your business and the previous tenant. For example, if you’re looking to open a
restaurant, a second-generation space where the previous tenant was a restaurant may be
perfect for you. Why? Because the space is likely to be outfitted with the proper ventilation
system for your kitchen. You may find that the lease includes commercial stoves and refrigerators.
It’s not uncommon for the new tenant of a second-generation space to slap paint on
the walls, lay new flooring, and open for business.
A downside of a second-generation lease is that it’s is going to reflect the previous
tenant. Also, If the space was previously leased to a long-term tenant, you need to
make sure the space is up to code! Conclusion
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By now, you know the important parts of commercial leases.
But there is still a ton to learn, especially if you’re an entrepreneur looking to find
a commercial space for your business. To dive further into commercial leases, check
out our Tips for Leasing Commercial Real Estate playlist here