Commercial Real Estate Leases
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!)
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.
Information in calculating pro-rata lease:
1,000,000 sq.ft. of common area
$60,000 total cost to maintain that area
$60,000 / 1,000,000 = .06 cents per sq ft.
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.
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.