Entering into a new commercial lease agreement for your organization will likely have a lasting impact in a variety of different ways. From obvious financial factors to slightly more esoteric considerations like space layout and functionality, a commercial lease is capable of shaping the direction and success of your company for both good and bad.
Therefore, understanding everything from the bold strokes to the fine print within any given agreement is absolutely critical before putting your signature to the dotted line. Of course, as a market leader in the commercial lease space, TenantBase is extremely well-versed in the intricacies of such agreements and has prepared a short guide that explains most of the key terms in a commercial lease agreement.
As with many aspects of life, understanding the vernacular is an important first step in making well-informed decisions. Using this guide, TenantBase hopes your next commercial lease will be thoroughly understood and, even more importantly, become a solid foundation for a prosperous future.
Start With the Lease Types
Given the wide range of different organization types and industries, it should come as no surprise that there are a variety of commercial lease agreement types to choose from. Although many might appear similar at first glance, it is important to fully understand the sometimes subtle variances between the different types, particularly since certain financial and property-related responsibilities could fall to either the landlord or tenant depending on the agreement. To that point, there are four basic agreement structures that you should be familiar with:
- Single Net Lease, Net Lease – In this type of agreement, the tenant is only responsible for paying utilities and property taxes. The landlord pays for everything else, including maintenance, repairs, and insurance costs.
- Net-Net, or Double Net Leases – With these agreements, the tenant pays for all utilities, property taxes, and insurance premiums for the building. The landlord is responsible for all maintenance and repair costs.
- Triple Net Leases – Essentially the opposite of the single net lease, this type of agreement places the responsibility for all costs of the building squarely on the tenant. Typically speaking, the only exception is for structural repair costs that generally fall to the landlord.
- Full Service Gross or Modified Gross Lease – Sometimes called a modified net lease, tenants and landlords split structural repair costs as well as operating expenses, collectively referred to as "base rent." Split operating expenses typically include property taxes, property insurance, common area maintenance, and utilities.
Aside from the factors specifically defined within each type of lease, it is also important to note that both fixed and variable costs could be significantly impacted by your choice of lease type. From maintenance and repair costs to required insurance covering liability, property, and other factors, make sure you fully understand which party is responsible for specific costs in order to avoid any unexpected and unforeseen financial pitfalls in the future.
Important Terms to Know
Of course, understanding the many moving parts within a commercial lease agreement is just as important as choosing the right type of lease to begin with. Defining a distinct set of common terms should go a long way in helping you decide if any particular lease agreement suits your needs, expectations, and best interests.
A predetermined minimum amount that the tenant must pay every month, base rent functions separately from operating expenses and revenue. It is almost always a fixed amount and is usually quoted on a square foot per year basis.
This monthly expense can be a variable line item that a tenant is charged apart from usable square footage or other typical rent costs. Specific expenses like after-hours services, HVAC, common area maintenance (CAM) fees, and percentage rent are often considered an additional rent cost and not included in the base rent.
Also known as abated rent, free rent refers to a specified number of rent-free months a landlord offers a tenant, usually at the very beginning or conclusion of a lease. There are rare occasions, however, when such benefits can be spread throughout the lease term.
A popular term across many facets of the real estate industry, turnkey is used to describe a space that is ready to move into. If time is of the essence and you have a narrow window to choose new office space, agree to terms, and move into the new space, a turnkey property can save you much-needed time and aggravation, particularly if you do not need to make any of your own upgrades to the space. In a turnkey property, all of the wiring, fixtures, flooring, and design or decorative items like paint and carpet are already in place.
Usable Square Feet
Usable square feet is a that metric defines the square footage that is rented and exclusively used by the tenant. In other words, usable square footage is the area of square feet used directly and solely by the tenant, including private restrooms available to the tenant alone, closets, storage, and any other areas of which only the tenant has access.
Rentable Square Feet
Rentable square feet is a term that refers to common areas that are shared amongst multiple tenants along with usable square feet. More concisely, rentable office space is calculated by adding the usable square feet of the office space plus a prorated share of any common areas. Such common areas typically include shared restrooms, hallways, staircases, lobbies, and recreational or common areas.
Given the importance office space holds within the overall performance of an organization, several types of insurance are available to tenants in order to cover many of the risks involved in leasing commercial space. Some of the more common types of policies used include property and liability insurance, business interruption insurance, and leasehold insurance.
As a slight aside, it is also important to understand the difference between property insurance and business interruption insurance if either or both types of coverage might be deemed necessary. In the case of a catastrophic event or disaster, property insurance will cover most, but not all, of any physical damage to the building or property. Business interruption coverage, however, would be used to replace lost revenue resulting from such a catastrophic event or disaster.
In many instances, tenants are responsible for carrying their own liability insurance as well as additional policies to cover the contents of the office space, including inventory and any tenant improvements made over the duration of the lease agreement. Often times, the landlord specifies a minimum amount of liability coverage required within the lease agreement itself. Additionally, while the landlord ensures the building for liability and property damage, they have the ability to pass such costs onto the tenants. If a landlord chooses to pass on these costs, however, they would be included in the base rent and not as one of the items considered additional rent.
No matter the type of lease, every agreement will obligate you to pay for the space for a specific number of months. The lease term represents the entire period your lease is considered active and, therefore, how long you are financially responsible for paying it, even in the unfortunate event of your business closing shop.
Often the source of considerable consternation and confusion, the different types of clauses found embedded within a commercial lease agreement could very well be the difference between a space and agreement that suits your particular needs well and one that can quickly become claustrophobic, constraining, and expensive. That said, it is critical to understand the three basic types of clauses commonly found in an agreement before making a final decision on any office space.
A use clause defines how a tenant will be allowed to used the leased space. Obviously, it's critical to make sure your proposed use falls within the terms established by any use clause and doesn't restrict your operations or particular needs. Likewise, since use clauses can define a wide variety of limitations – including broad restrictions specifying what type of business will be conducted within the space, narrow definitions that might restrict the types of services or products you offer, or even subjective terms based on the quality level of your operation – thoroughly understand such a clause before agreeing to any lease.
Aside from what's actually spelled out in the agreement, it's also important to determine if any local or state restrictions will limit your proposed use or require permits and approvals for your particular business.
A term clause in your agreement defines the length of your lease and specifies the commencement date, expiration date, and sometimes any renewal options as well. Before signing, it's in your best interest to take a realistic look down the road to determine the viability of the space in the future relative to your expected growth.
For instance, if explosive growth is a distinct possibility within a short amount of time, a shorter lease might serve your needs best in case you find yourself needing a larger space not too far in the future. If such is the case, an agreement with restricting renewal options can protect you from being unable to relocate your business after a period of rapid growth. Granted, your organization might have to deal with cramped quarters for a bit of time but it's obviously better to have too small of a space rather than no space at all.
While it might seem fairly obvious from a distance, a rent clause can include additional factors other than simply the amount of rent you will be paying. As an example, automatic rent increase mechanisms could be included within a rent clause that could significantly impact your financials over the course of the lease. Also, such a clause could include a provision that decreases rent if a tenant makes improvements or repairs to the building.
Although these three types of clauses encompass the majority of what might be found in a typical commercial lease agreement, they in no way represent all types of clauses. To protect your best interests, also look out for sublease clauses, exclusivity clauses, and co-tenancy clauses as well. Since a lease agreement is subject to negotiation from both parties, such negotiations could alter, add, or remove any clauses that might not suit either party well.
Finding sufficient office space is only the first step in locating a new home for your organization. Unfortunately, even the most ideal space imaginable will be ill-suited for your needs if the agreement isn’t to your liking and specifications. For that reason, TenantBase hopes this quick guide helps you better understand the terminology in any agreement to make your next move well-informed, productive, and an important step in reaching your company’s long-term goals.