A business tenant typically owns the business but not the building out of which they operate. This is the case for the vast majority of businesses throughout the country. As a tenant of a larger commercial landlord, there are a number of items that you should consider before signing a lease. In a commercial lease, every paragraph and clause can have a significant impact on your company and your bottom line.
The Complexities of Commercial Leases
When entering into a commercial lease, it is very important to do so with the advice of a competent, local attorney with experience in drafting and reviewing commercial lease agreements. If you are a tenant in a commercial lease relationship, you are not protected by the consumer laws that cover the landlord tenant relationship in a residential lease agreement. Also, there are no standard forms that govern the lease agreement as is the case with residential agreements. These factors and the fact that much more money and time (in terms of the length of the agreement) is usually at stake, make commercial agreements far more complex and difficult to negotiate. As mentioned above, you will be best served by having legal counsel by your side helping you to make the best decision for your business. Having a real estate attorney review the document before you sign is critically important to the success of your business. This is particularly important for a business tenant signing a commercial lease for the first time.
Types of Commercial Leases
There are three main types of commercial leases available for business tenants, each with its own unique traits and allocation of property expenses. This is the main issue for business tenants signing a commercial lease – the distribution of property expenses between landlord and tenant. Property expenses include real estate taxes, property insurance, and common area maintenance.
The first type of commercial lease is a gross lease, in which the landlord covers all property expenses, and the tenant pays a monthly cost for rent of the space. Often called a “full-service lease,” this is a short-term commercial lease agreement wherein the property’s landlord is responsible for paying the ongoing operating expenses for the property. For example, the landlord will usually completely cover the property’s insurance, maintenance, utilities and property taxes in a gross lease agreement. To prevent abuse, it is common for gross leases to have an “expense stop clause” that specifies an amount above which the tenant is required to pay for a given expense. An expense stop clause may specify for instance that after a certain dollar amount, the tenant assumes responsibility for a specific utility – but only for the overage amount.
Modified Gross Lease
This type of gross lease usually requires the tenant to cover a portion (or all) of the expenses after a term (usually a year into the agreement). Modified gross leases ensure that both parties, landlord and tenant, share financial responsibilities for utilities, insurance, maintenance and/or property taxes.
“Net lease” is an umbrella term for several different types of commercial lease agreements in which the tenant takes on responsibility for paying a part of a property’s operating expenses, as well as the required rent. There are several sub-categories of net lease, including: Single Net Lease, Double Net Lease, and Triple Net Lease (NNN lease). A triple net is the most common. It stipulates that all operating costs (insurance, property tax and maintenance) be paid by the tenant along with the rent for the property.
Strip malls, shopping centers and other retail commercial landlords will sometimes utilize this type of lease. A percentage lease agreement allows the landlord to charge a fixed rent, as well as collect a percentage of the tenant’s gross sales during a specific period (usually a month).
Basic Lease Considerations: Term and Rent
The two most basic terms in a commercial lease are the term and the rent. The term of a commercial lease can either be short-term or long-term, with advantages and disadvantages to each. With a short-term lease, tenants can renegotiate terms if the market changes faster than with a long-term lease and are good for newer businesses that are unsure of their initial success. However, if the market changes in favor of the landlord the new terms of a short-term lease can go against a tenant and constantly renegotiating commercial leases takes time and money.Long-term leases work well for businesses that are confident in their continued success and want the stability of commercial lease terms that will not change during the duration of their time in the space.
Keep in mind that for a tenant purchasing a business utilizing an SBA loan, the lease term with tenant options to renew must equal the whole length of the loan, which is typically 10 years. So, something like a 5 year lease, with a 5 year option for the tenant to renew would work for the bank. Options should be specific, and vague language like “new rent to be negotiated,” aren’t normally in the best interest of the tenant and the SBA lender will require specific option terms.
The term provisions in a lease should also contain the date that the tenant can gain possession of the property, the date that the obligations of the tenant and landlord will begin, whether the tenant can automatically renew the lease, and the termination date of the lease. An experienced real estate attorney can go over the basic lease provisions with you to ensure that all relevant clauses are included in the agreement before you sign a commercial lease with a landlord.
Rent in a commercial lease is set forth either in outright terms or calculated by formula that should be included in the lease terms. Typically, rent falls into one or more of the following categories — base rent, additional rent, and percentage rent. Base rent is a monthly fixed amount paid to the landlord, whereas additional rent is often paid by the tenant for the costs of operating the property. Percentage rent is an agreement by which the landlord receives a portion of the tenant’s sales as rent.
Additional Terms in a Commercial Lease
There are no standard commercial lease forms, so it is important to read each one to ensure that it contains all of the relevant provisions that inform you as a tenant. Some of the most common additional terms of a commercial lease are found below, but it is critical that you review a commercial lease with a knowledgeable real estate attorney before signing an agreement to ensure that there are no provisions that take advantage of tenants or subject them to unconscionable terms.
This is a lease concession that means rent that you don’t have to pay. Usually “abated rent” refers to the first few months of free rent commonly given to the new tenant as an inducement to move in. The idea is that you are just starting out, completing the move-in, and getting ready to do business, so they give you a break.
Of course, it is not truly “free”, but merely amortized over the other months that you are paying. Since a 2 or 3 month rent abatement is typically included in a commercial lease for years, you have to calculate your choices of spaces by including the benefit of that free time, or if you don’t need it, reducing the monthly rent amount.
Sometimes, free rent is included for slow business months. For example, your business might be slow during December, so you negotiate for abated rent each December for cash flow reasons.
Alterations to Leased Property
The commercial lease should state in no ambiguous terms about the rights and obligations of the landlord and tenant to make alterations and improvements to the commercial property. Unless specified otherwise, a tenant is not allowed to make alterations to the property without the landlord’s consent.
Assignment and Subletting
Unless the commercial lease states otherwise, a commercial tenant is allowed to assign or sublet the space per the terms of the lease. This allows the tenant to give the space to another commercial user for a set period of time or for the remainder of the lease term.
Usually, this comes up when you want sell your business to someone else. They buy the business and take over the lease. Normally, the landlord must approve the assignment. The landlord can condition their approval of the assignment on his getting higher rent, or a pay-off. You may or may or may not be released from secondary liability. If it’s a possibility that you might sell the business during your lease, you can avoid such problems by adding appropriate terms to the lease which prohibit the landlord from complicating the deal.
Insurance clauses in a commercial lease dictate whether the landlord, tenant, or both parties must obtain insurance for the space, what type of insurance is required, and what minimum amount of insurance must be obtained.
All commercial leases should clearly state the terms of late rent payments. It should include the amount of the late charge and/or interest on the late rent payment. This allows for an alternative to the landlord terminating the lease for nonpayment of rent.
Repairs and Maintenance
Unlike residential properties, a commercial landlord is not typically required to repair or maintain a commercial property for its tenants except as required by the lease. As such, tenants should try to negotiate a repair and maintenance clause in their commercial lease to obligate the landlord to make repairs.
Most commercial landlords require a security deposit, and typically there are no restrictions on the amount that a landlord can request for a space. The purpose of a security deposit is so the landlord can pay for any repairs after the tenant moves out or to pay the landlord rent if the tenant fails to do so.
Tenant Improvements. These are the physical changes in the proposed lease space that will be made to accommodate your business layout and needs. Walls can be moved or built, utilities installed, kitchens and rest rooms built, lighting changed, doors added, lofts built, ceiling lowered, carpeting and painting done, and whatever else is required. This can be negotiated with the landlord. They will often offer a fixed amount towards T.I. as a lease incentive, or in some cases the tenant will be responsible for the construction build-out of their unit.
A piece of equipment or a structure that is used in your particular type of business. Stoves, dishwashing machines, and stainless-steel counters are among the trade fixtures for restaurants. Dental chairs, X-Ray shielding, and sinks are among the trade fixtures of dentists. Reception windows facing the customer area, and the wall containing it, is not a trade fixture because other businesses might use such a structure. There are gray areas between these obvious extremes. Make sure to check your lease to see if trade fixtures may be removed or must remain once installed. Trade fixtures are normally permitted to be removed (if the lease allows the removal), as long as the tenant repairs any damage caused by the removal.
These clauses clearly dictate what the tenant is and is not allowed to use the commercial space for. This also dictates how to handle disputes among commercial tenants if multiple tenants lease in the same building. This could be a limited use clause, which only allows for the tenant to use the space in its authorized capacity or should articulate what specific uses the space can utilize.
Typical Landlord Requirements for Tenants
Buyers always ask us what requirements landlords have for their tenant applications, and the answer is “it depends on the landlord.” Major commercial landlords and corporate property management companies will have vastly different criteria and minimum standards from a smaller more local landlord. So, it really does depend. We’ve compiled a list of the most commonly requested items, so that buyers can prepare themselves for this part of the lease application process with the landlord. Please be advised that this is by no means a complete list.
Deposit amount (will vary, based on strength of applicant)
Prior commercial leases and references from past landlords
Experience owning/running a business in the past
Financial records of the business
Sales Tax on Commercial Rent in Florida ONLY
Florida is the only state in the United States to impose a sales tax on commercial rent. For years now, the state of Florida has considered itself at a competitive disadvantage for companies looking to relocate because of this tax. The problem is, the state made over $160 million dollars a year on the tax, so removing the tax must be done slowly, over time. For several years the state reduced the commercial rental sales tax rate small amounts with the latest reduction to 5.5% (plus the local surtax) effective January 1, 2020. There was legislation to reduce the rate to 5.4% in 2021, but the legislation was never enacted because the economic tsunami of Covid-19 started to hit while the legislation was pending. The state tax plus local surtax results in a commercial lease tax ranging anywhere from 6-7% depending on what county the property is in.