Types of Commercial Lease Agreements

Before signing a lease, I strongly advise you to consult your lawyer. They are not only legal and binding contacts they are a huge expense to your business and unfortunately, there are risks.

We have listed some of the most common rent structures landlords use when negotiating a lease with their tenants:

Gross Lease

For anyone wanting to lease a space, this particular lease sounds like the simplest type of lease to understand and it is the most commonly used for office space. You pay a flat monthly rate based on the square footage in your space and you do not have to worry about any other expenses such as real property taxes, insurance, utilities, and maintenance. The owner of the building pays these operating costs also known as common area maintenance or CAM.

Full-Service Gross Lease or Modified Gross Lease

However, if you did not negotiate to pay a quoted rental rate that does not change throughout the term of your lease, your rate will increase after your first year if the owners building expenses increased. The increase depends on the percentage the owners operating costs increased and if you negotiated an expense stop.

So again do your research. If you sign a full-service lease then review with the landlord what operating costs increased and by how much and if you can, look at the costs and how they fluctuated over a period of five years. Also, it is important for you as a tenant to have in writing in your agreement the exact operating costs that will be paid by the owner of the building.

A modified gross lease is attractive to some small businesses because it requires the landlord to be responsible for the maintenance of the building. It also gives the tenant direct control over the costs it pays, such as electricity. For landlords, a modified gross lease enables them to retain control over their property. It allows them to keep the property maintained and avoid maintenance conflicts with careless tenants.

It has been noted, that entrepreneurs probably sign more Modified Gross Leases than any other.

Net leases

There are three types of net leases – Single Net, Double Net or Net-Net and Triple Net Lease (NNN Lease)

  1.  Single Net Lease. This lease requires you to pay rent plus a portion (Pro-rata share) of the building’s property tax. You are not   responsible for insurance premiums or other maintenance costs. This is the least common type of lease used by landlords.
  2.  Double Net Lease. This lease requires you to pay the property taxes and the insurance premiums (based on the amount of space you   are leasing) in addition to your rent. The landlord pays for all other exterior maintenance costs.
  3.  Triple Net Lease. This lease requires you to pay a share of all three additional expenses including rent, property taxes, insurance   premiums and other costs such as maintenance and repairs to the building. The rent is typically lower than the gross lease but if the   costs get out of control and you signed a bondable net lease that stipulates the lease agreement cannot be terminated if the costs   increase then you are responsible for the term of the lease. Landlords prefer using this lease agreement. They typically estimate their   expenses and charge the tenants a portion of these expenses based on the sq. footage they are leasing. However, if you do not read the   fine print your rent could not only fluctuate year to year but also month to month.

Percentage Lease

This lease requires you to pay a fixed rate plus a percentage of your gross income. They are commonly used for high-end retailers in multi-tenant locations such as malls and shopping centers.

What to watch out for!

Rentable vs Usable Space – The actual space you are renting is referred to as usable space and yet it is very common for landlords to include additional space including the lobby, hallways, stairs, and elevators to the calculation of your rent. So ask your landlord how he or she determines the amount of space that you will be charged and using.

Buildings Operating Expenses – You may be charged for some expenses that do not apply to the space you plan to rent. For example, the landlord may be charging you extra expenses such as penalties because he failed to pay taxes on time, other fees, and higher interest charges because the landlord refinanced his property; legal fees to resolve disputes with other tenants, or other structural repairs or replacements; capital improvements such as a new HVAC system are often absorbed by the tenants.

Be sure the percentage of common area maintenance charges is based on the size of the building and does not vary based on how much of the building is rented.

Escalation Clauses – Escalation clauses are both valid and very common in agreements and are used by landlords to pay for increases in the costs of their building. The clause allows a landlord to raise the rent if the cost of maintaining or operating the property increases. Most landlords will negotiate the escalation clause with you. Typically the CPI (consumer price index) is used as a guide to increase rent annually by the increase in the CPI index. The risk that you take is if inflation were to increase, you rent will also increase. So structure your lease for annual caps such as 3%.

Sometimes $12 a sq. ft. can climb to $20 a sq. ft. in a hurry.  Watch it!

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