Commercial Real Estate Leases

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Commercial Real Estate Leases Part I


Basic Types of Leases: How your tenant invoice is determined.

First: Why a new lease now?

Location, location, location

The location of your business is the most important aspect of a successful business. A business needs to be where their customer are at.

Right now, there are plenty of vacancies in most commercial real estate venues. If there was ever a time to make the move to a better space, this is it. It may seem counter productive to move during a down time but when will lease rates be lower? When will landlords be more inclined to deal on common area caps and lease improvement credits? Certainly they will not be so inclined in a market where there is little product.

Here is another reason that landlords need to deal right now. Landlords have mortgage payments to make and need to fill-up their spaces with paying tenants in order to make their payments. Also, landlords cannot sell properties that are not successfully leased-up. Landlords must absorb more of the CAM, common area maintenance, cost to maintain properties when there are vacant stores, too.

So, look around and find your number one top space!

Then, spend a bit of time understanding the basic lease clauses in a commercial real estate lease. Information is power!

Types of Leases

There are several types of leases. The type of business you operate and the type of property you lease will determine which of the lease types you will be negotiating for.

Do you remember your first apartment lease? It was a flat or fixed lease. A single rent is set for a definite period of time. It may or may not include various utilities.

A Gross lease is most often used in an office building. A gross lease is where the tenant pays a flat monthly lease and the Landlord pays for the building operating costs. Often the tenant will pay for their utilities. In older buildings the landlord may pay the costs for utilities and bill those utilities back to the tenant based on the square footage of the lease. There is usually an escalation clause in these leases that raise the cost of the lease on an annual basis.

Net leases include a base rent plus a share of the building or property’s operating cost. This cost is called CAM, common area maintenance. The operating costs are billed proportionate to the square footage of the leased space.

Net Net leases include a base rent, pro-rata share of real estate taxes, and pro-rata share of common area maintenance fees.

Triple net leases include all of the above, basic rent, CAM costs AND an additional charge called percentage rent. Percentage rent is based on sales of the tenant. This was devised so that base rent could remain lower until the tenant became as successful as the landlord forecast. The tenant did not have to pay the high rent from the first day but when they made the high sales they then paid the rent the landlord originally wanted.

Got that? Both parties agree to a break-even point where the tenant must pay, say, an additional 6% of each dollar they net back towards more rent.

In some older leases the percentage rent collected is often much higher than the original base rent!

There are many complicated negotiations over percentage rent. As the tenant you need to be completely confident of the number you need to reach to justify additional rent in the form of percentage rent. The landlord has access to a great deal of information regarding your business type from organizations such as ULI, Urban Land institute, and the ICSC, International Council of Shopping Centers.

When times are tough all kinds of hybrid leases are devised. The methods include mixtures of the above and are designed to fill the empty spaces in creative ways!

Here are just a few of the hybrid types of leases.

Percentage Leases are often used to fill a space with an incubating or new tenant. This tenant has negotiated to pay only a certain specified percentage of their lease as rent. They may or may not pay CAM costs. There is no base rent figure.

CPI increase leases are used in times of high inflation. These leases base rent are tied to the Consumer Price Index which fluctuates with inflation. Usually, the lease CPI fluctuation has some kind of cap on the price fluctuation. Otherwise, a tenant could see their lease rise as much as 18%. (See the early 1980’s!)

Common Terms:

CAM, common area maintenance, fees include a wide host of costs but all of them are directly related to the maintenance and repair of the common areas that you, your employees, and your customers use to reach your leased premises. This includes cleaning the area, picking up trash, lighting the area, plants in the area, security, or any other myriad of expenses that are needed to maintain the common areas. There will be a lengthy clause in the lease describing what CAM entails. Read this clause carefully.


Pro Rata math is a method to devise a fair way to charge the tenant for use of the common areas. A tenant's invoice from the landlord will contain many charges that are calculated using pro-rata.

Example:

Information in calculating pro-rata lease:

1,000,000 sq.ft. of common area

$60,000 total cost to maintain that area

Math:

$60,000 / 1,000,000 = .06 cents per sq ft.

Or

The cost of maintaining each sqft is .06 a year

If you lease 4,000 sqft, you will pay 4,000 X .06 or $240.00 a year.

Got it?

Oh, it is usually billed out monthly, so take one more step and divide the $240 by 12 (mos) and expect a charge of $20.00 per month for CAM.

One more thing, this is a ridiculously low number for CAM. It is more likely to be $6.00 per sq.ft. So, the cost is more like $2,000 a month on 4,000 sq ft leased space.

($6.00 X 4,000 sqft = $24,000 paid by month or $2,000 a month)

.So, first off you need to figure out just what type of lease you are dealing with.

Next, installment, understanding basic lease clauses.


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Comments 35 comments

Iris DuFresne 5 years ago

I am hoping to open a business soon, and I find it interesting that there are so many things to consider when thinking about a lease and what location to choose. I often see a site where one business after another opens and closes. The site just doesn't seem to be a very good one for any type of business. There are others where a business is finally a success after lots of others failed. I think that this really proves...location does matter.


nmgraduate 5 years ago

This does make sense. Along the same line I have been debating on purchasing some real estate due to stagnant prices with the bad economy. If I was a landlord that seems like the right choice and do wonder how many owners are more stubborn with their rates and not the economy per se.


Baja208 5 years ago

Just as the article states: it is hard to rent out these spaces when there are so many vacancies to be filled right now. Yes the time is great to purchase new doors, and believe it or not, creditors are extending beyond generous credit lines to those individuals interested in commercial real estate right now, but again this doesn't do investors much good right now when we can't even realize a profit on our investments. I will still admit that it is a great time to buy for long-term use, but tying up all that cash in property that can't even currently pay for itself is an extremely risky move. From my experience those who own a particularly valuable location, as noted by Iris, are already taken up leaving either one of two scenarios. The first is that it is an apparent bad location and thus not even worth the risk to business owners, or that there are "stubborn landlords" (nmgraduate) whom do not wish to take their property off of the market and possibly miss out on a better opportunity that may pay more in rent.


asimon11 profile image

asimon11 5 years ago

It amazes me to learn about all of the processes that go into creating a business. I never knew that there were so many different types of leases. I plan on opening my own business and reading these posts opens my eyes to the dynamics of how to start it up. It's nice to know that now is a good time to buy commercial real estate and that it is likely you can find a spot in a great location for a low price!


Kileen 5 years ago

I agree that location is a huge factor on a business's success. But there are other reasons a business closes its doors.

A good example is Moses Home Store, owned by a local named Moses. This was a small but up-scale home decorating store - one of my FAVORITES in Albuquerque. It was originally located in the strip mall which shares a parking lot with Target on Montgomery east of Wyoming. Then they moved to what I consider a MUCH better location: the corner SE corner of Paseo del Norte and Wyoming. The store was always busy and was doing well.

They were open for less than 2 years when Moses decided he didn't want to be in retail any longer. He closed his doors and now does commercial interior decorating.

Point being: two years later, that space is still available and is a great location!


DBluehorse 5 years ago

Wow, after reading this article I need to revisit my "tentative" business plan. It's good to know that there are various types of leases to consider and whether it will support the type of business I am considering. I need to consider revisiting the cost(s) of leasing property on tribal land or state land also. So many factors to consider when starting or opening a business. Thank you for this article, it help shed bright lights for commercial leasing.


apeperas 5 years ago

Wow, I did not know there were that many types of leases. I am familiar with the lease about rent because I pay rent monthly. Location is exactly right because if the business is not in an area to meet operating costs and the fees of the land, then there is no reason to be in business.


Mandy Wittenbrink profile image

Mandy Wittenbrink 5 years ago

After reading this article, I am curious as to what type of lease I'm in with the apartment I live in.

However, I slightly disagree that location has a big impact for a business/apartment complex, etc. I say this because I live in an apartment across from the Tanoan neighborhood (an area where houses are very expensive) and I pay $868 monthly for rent, but the apartment complex right across the street from my complex, pays monthly rent of $1200. I'm assuming that it's because they have different lease options like the ones stated above. But if location is 'everything' then why isn't the monthly rents of both apartment complexes around the same range since it is in the same location area??


BusinessOpsMngmnt profile image

BusinessOpsMngmnt 5 years ago from USA Author

Hi Mandy,

The idea that location location location is the most important factor is related to price in many different ways.

Rental rates are impacted by these (and other factors!)

How old are the apts?

When did the current owner buy them? (how big is their monthly payment? Generally, the newer the owner the more the rent!)

When were they last updated?

How much did that update cost? (increase rental to pay for those updates)

What are the features in the apts?

How high was the vacancy? (quick, lease it up because we have so many vacancies and cannot make a big payment that is coming up! so, reduce rates now!)

Very nice thinking on the subject. Hope this helps.


Isabela Thomazelli 5 years ago

I also find it very interesting that there are so many different leases. I can see how having the understanding of your lease affects your business and directs towards one or other location. I find myself in a siuation that my landlord has written my house's lease very poorly, and I often do not know if he is honoring his responsabilities as far as the house is concerned. Again, from my own experience, I see the importance of each and every clause of the lease for a business or even for a student while looking for housing.


isathlli profile image

isathlli 5 years ago

I also find it very interesting that there are so many different leases. I can see how having the understanding of your lease affects your business and directs towards one or other location. I find myself in a siuation that my landlord has written my house's lease very poorly, and I often do not know if he is honoring his responsabilities as far as the house is concerned. Again, from my own experience, I see the importance of each and every clause of the lease for a business or even for a student while looking for housing.


Amy Xuan profile image

Amy Xuan 5 years ago

I find this article very interesting!!

I also learned something related to leases in another subject this semester. It is said the leases can be classified into two types: operating leases and capital leases. Operating leases are just the most common types, while capital leases occur when the lease contract year covers the majority of the usage year of the property. Capital leases can be considered as financing activities, as it can help to ease the financial pressure.

And I also fully agree that location is definitely important for leases. Here is an example: in my hometown, there are two stores located in the same place; one faces to the main street, one does not; the rental fee of these two stores different a lot from each other.


chow sau ling 5 years ago

It is inevitable to sign a commercial lease in daily lives, especially for those who want to set up their own business. By knowing the details of a lease is extremely important to avoid getting into trouble.

Personally, I hope to operate a small business in the future. Thus, I have to find a good location with appropriate lease terms to facilitate the operation of my business. Many people do not look into details about the terms in the lease agreement, so it turns out that there are many conflicts between the landlords and tenants. Read the details; discuss what they mean with a broker, the landlord, and other experts. Your business will be constrained by the terms and conditions in the final executed commercial lease. This document matters read and understand each provision.

As a result, we have to go through the lease contract thorouhgly before we sign the documents. we need to "Take that seriously"!


lilyperez 5 years ago

The only thing I have ever leased is my apartment so I have only dealt with flat leases. However, over the years the lease terms have changed and, of course, my rent goes up everytime I sign a new lease. In fact, in the past 3 years my rent has increased $150 to $200/ month for the same apartment. I have seen a triple net lease at work. Each month we had to pay a % of gross sales tax to the landlord.


Frank Lucero profile image

Frank Lucero 5 years ago

It seems me that triple net leases are a total scam. If one did not consult a lawyer before agreeing to pay a percentage of rent would make the business owner pay more rent the more successful he/she is ridiculous. Plus, no business owner should not inter into a lease agreement or mortgage without having the right kind of lawyer look over the document first. A business owner must not rely on the word of the real-estate agent because the agent may be getting a commission of the percentage of the lease.


MelinaChavez 5 years ago

I definitely agree with Frank. I find it absurd that the tenants success determines their percentage rate. At times the landlord may take advantage of the fact that the tenant might not have much knowledge over percentage rates making it easier for the landlord to set one that benefits them since they have plenty of experience with the matter. I think everyone that is going to sign a lease agreement must consult with a lawyer or someone with extensive knowledge about leases because many individuals can be taken advantage of especially in today's economy where everyone is trying to fen for themselves. There are many lease options and tenants should be entitled to know about them so that they make the right decision when signing leases.


Phillip Valencia profile image

Phillip Valencia 5 years ago

From a small town and business perspective, I find that many of these leases are not so common. However, many of these leases are creative and workable. It's those types of solutions that will keep folks in business.


rj-romo 5 years ago

I actually work for and own a small business in town and as of this upcoming month our lease is up and we are due to either sign a new four year lease, one year, or totally opt out and cancel our lease all together. Obviously we arent going to be doing the last but we have been going back and forth with our landlord to re-negotiate our current contract in order for it to better suit our needs. Our landlord has a lot of different properties throughout the state and an increasing amount of them are becoming vacant. Right now re-negotiating is very simple and effective for our business and our landlord is more than happy to work with us and has given us a lot of room in our contract. So all in all it is a good time, due to the slack economy, to buy or re-negotiate property leases. Its better to fill up space with lower rent than have empty spaces bringing in no money at all.


Forrest Grace 5 years ago

Very interesting article. I feel that the same attitude of now is the time can apply to many fields in the business world. I hope one day to own my own business as well. I also hope to flip houses on the side. What I mean by flip houses is that you buy a not so perfect house and fix it up nice while you live in it and then sell it for some profit. I know the real estate market is down now and will probably never be as strong as it was, but money can still be made. Especially if you are able to buy now when the market is so low. I am confident it will rise. It is interesting to learn about these types of leases, it could prevent bad choices in the future. thank you.


BusinessOpsMngmnt profile image

BusinessOpsMngmnt 5 years ago from USA Author

Yes, I have heard the opinion that triple nets are not good many times.

However, when (as the Landlord) I would point out that we needed $20psf and would allow them $18psf until they built up their biz..sometimes they would understand.


hodgins 5 years ago

At the start of this article they are talking about how location is the most important thing for a business. Talking about location, there is a location in my home town where there has been at least 4 different restaurants in the past 20 years. All of these restaurants have been local mom and pop businesses. There has also been a variety of food types. All the way from chinese to italian. In my opinion there are two main reasons why these restaurants have failed. First, the location is on the corner of a busy three street intersection, so it is hard to get to. Second the parking lot behind the restaurant is very small, so there are never a lot of customers at one time. I wanted to discuss this location because even though there has been many restaurants to close there the next business to take over the location is another restaurant. Why not try a new type of business for this location?


Andrew Pena 5 years ago

Like the article says location has a lot do with a success in your business. In my own opinion the location is the master piece of making your business taking off or failing. Also taking all those leases into consideration is a very interesting deal and having to deal with them too. Like my father owns a towing service in Cuba NM and there is only one towing service in that location. As an owner of this business he's always on the road and bring in business summer and winter.


Mahvand Biazar 5 years ago

Lease problem is not only in the commercial sections, but also residential sections have similar problem is this saturated market. Landlords cannot afford their mortgages and their other expenses without renting, and the real estate market for sale is not favorable in the current economy. Many times in residential lease the tenants that are out there hunting for rent cannot afford the rent, and they do not know themselves till they star renting, and then they default. The story of the renting is very similar to the story of the banks lending money to people without evaluating their financial affordability. Not many ordinary people know that how much of their income should go for the rent expense, or how much of their income should go to their car payment. And this concept is actually very difficult, and people are not familiar with the basic financial ratios. I have recently heard from many landlords that they have rented their houses; the tenant has defaulted in their payment, and many times at the time they had rented the place they had a job, but later on they have laid-off and they cannot afford the payment. I guess this is problem of landlord in the current market. Different types of leases were interesting in this article that I did not know them. -Mahvand Biazar


bkhodaie 5 years ago

I agree that now is a good time to look for a new location with the market in a slump. But the company needs to evaluate the location carefully. They need to find a location where there are other thriving business or else the is less of a customer base to pull from. It is also important that the business evaluate the cost of ending the current contract lease before just up and moving.


Aaron Major profile image

Aaron Major 5 years ago

Location is definatly the most important factor to consider when opening any business. This is even more true right now with the current economy because people are spending less money. You want to be in popular places where business thrives. Landlords dont ever like empty spaces so the article is right, before you think that space is to expensive, think again. I did however find it very interesting all the different leases that are out there. If I were to open a business right now I would consider hireing a professional to look over my lease. Do people often do this?


egs1016 5 years ago

The bank I work for just opened their first full operation branch here in Albuquerque, and it was interesting to see the leasing process from an employee's point of view. The space the bank moved into is very nice, however there was no opportunity for input from the few employees who had been working in a very small office in Albuquerque which did not have any account services or teller services but knew what kinds of things customers had actually come in looking for. Long story short, the probability that this branch will grow very quickly and outgrow its space within at most 12 months is very high. The management will have to deal with possibly renegotiating the lease when there are suddenly more employees than chairs in the office, but this is a problem that could have been foreseen.


BusinessOpsMngmnt profile image

BusinessOpsMngmnt 5 years ago from USA Author

Aaron, and others,

Every professional company uses a R/E Lawyer. Only smaller cos. try and wing it. The cost of a bad lease is much more expensive than a R/E Lawyer!


oldani 4 years ago

I did not realize how many different types of leasing options there are. I think the triple net lease is an interesting way to lease a building to someone. I think that it is very beneficial to new business owners looking to rent a space. This allows the entrepreneurs to start a business without having to loan as much money for the start up costs in order to meet rent each month. The only question I have about triple net lease is once the renter is able to pay the full amount that the landlord originally wanted, can the rent continue to go up from the original high rent or does it stay at a fixed rate?


stevenrc 4 years ago

The fact that there are so many ways to lease commercial property was not something that I had previously considered. It would serve a new business well to be informed about these various options while searching for a place to launch their new enterprise from. In a difficult market such as this, it would also greatly benefit the landlord to work with new tenants. There is more emphasis on internet commerce than ever these days, this new angle provides potential tenants more options as far as getting space. Perhaps this new form of competition with spur even more different types of leasing arrangements.


josh2222 4 years ago

This was a nice review of the commercial real estate lease segment of my MGMT 490 Real Estate Principles class.

The current market has ample opportunities for businesses to search for the optimum location and lease. Businesses are able to be more aggressive in the lease terms now since landlords are aching to find good tenants. For any relocating business, they could probably benefit quite a bit from dealing with a professional brokerage company like CBRE who can help them find a great location with an inexpensive lease. This is a great time for any business to try to relocate or re-negotiate their lease terms to decrease their expenses. For those businesses that are doing good in these times, expanding might even be in the equation.

Furthermore, I am curious about how much businesses are pushing lease terms with the current and future economic factors.


Raa6012 4 years ago

There's so much that goes into starting your own business, it makes you feel for the small businesses in the city. Makes you kind of appreciate them a bit more.


Jnrobin01 4 years ago

I never knew there was so many different types of leases. This article made me want to go and take a look at my lease for my apartment and see what it contained. With this article, and the lecture given to us in class maybe next year I could negotiate a better deal.

This would also be useful when I graduate from college and go out into the job market. Knowing this kind of information would assist me to either opening up my own business, or negotiating for what ever job I might find myself in.


Varissa profile image

Varissa 4 years ago from Albuquerque, NM

Its interesting to learn that there a several types of leases you can consider when looking to buy retail space.I've always been curious about these type of leases (i.e. different companies located in bank buildings, etc.)and how they worked. I've worked for many small businesses in the past and had have to deal with various types of leases. However, I've never had to deal with gross, pro-rata, percentage, CPI or triple net leases.


Coopis 4 years ago

Jordan Cooper Op. 300-001

An interesting article I read on NY times last week concerning location: http://boss.blogs.nytimes.com/2011/12/07/is-it-wor...

In the story a Chicago based yoga company has experienced two floods in one year at its headquarters. The once flourishing business is now failing under the financial stress caused by the floods and un-recouped insurance. The location, perfect for sales and customer traffic, is unfortunately right on the Chicago River.

Choosing the perfect location can be more than just a numbers game. Factors such as weather and the surrounding environment can be overlooked. Factors and scenarios related to location must be understood from all angles to prevent good businesses like this one from failing.


Coopis 4 years ago

Jordan Cooper Op. 300-001

An interesting article I read on NY times last week concerning location: http://boss.blogs.nytimes.com/2011/12/07/is-it-wor...

In the story a Chicago based yoga company has experienced two floods in one year at its headquarters. The once flourishing business is now failing under the financial stress caused by the floods and un-recouped insurance. The location, perfect for sales and customer traffic, is unfortunately right on the Chicago River.

Choosing the perfect location can be more than just a numbers game. Factors such as weather and the surrounding environment can be overlooked. Factors and scenarios related to location must be understood from all angles to prevent good businesses like this one from failing.

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