20 Terms You Need to Understand Before Signing Your Commercial Real Estate Lease

Understanding and negotiating the terms of a commercial real estate lease can significantly impact your company’s future success. Make one misstep, and you could be on the hook for costs that eat into your profits for years to come.

A lawyer specializing in commercial real estate lease agreements and an experienced commercial real estate broker will be your best friends during this process, as they’ll both be ready and able to advocate on your behalf.

Below, you’ll find issues to consider before you ink even a single clause, plus must-know information about many of the terms you’ll encounter so that you can head into your lawyer’s office and negotiations feeling more confident and better prepared.

Things To Do Before You Sign Your Commercial Real Estate Lease

Once you’ve found a suitable location for your business, it’s important to get as many of the unknowns off the table before you begin lease negotiations – including vetting your prospective landlord. Although you won’t be able to change who they are, having insight into what they value and how flexible they’re likely to be will help when negotiating your lease.

The four different types of landlords you’ll encounter include:

• Mom-and-pop type operators
  With three or fewer properties in their portfolio, they’re often straightforward, easygoing and interested in finding tenants who’ll pay their bills on time and treat their space well. They’re usually a good fit with small businesses that don’t make many demands in terms of renovations.
• Family investors
  These landlords have been in the commercial real estate business for a significant amount of time and because leasing space is the family business, they still like to operate their properties with a personal touch. A stable monthly cash flow is vital to them, so they’re willing to adapt and grow with their primarily small- to mid-sized commercial tenants so they put as long as possible.
• Management companies
  These companies don’t own the property they lease. Instead, they manage it for an owner who hires them. These landlords are less flexible with their lease terms and are best suited to more established businesses.
• Real estate developers
  These companies acquire and develop office, hotel, retail and mixed-use properties. They usually manage prestigious Class A buildings which compete for premier tenants who want to make a statement with their premise design or location. Tenant rent at these properties is usually above the neighbourhood average and is best for established companies with deep pockets.

Understanding Key Differences Between a Residential Vs. Commercial Real Estate Lease

While both residential and commercial tenants pay rent to a landlord, their leases differ in the following ways:

• Rent Protection – Unlike the rent protection that residential tenants enjoy in various regions in Canada, commercial tenancies laws do not limit or guide rent increases. Your lease should clearly outline your landlord’s planned rental increases.
• Duration – While residential leases usually last only one or two years, commercial real estate leases can last from three to ten years or beyond.
• Flexibility – Residential leases are generally not flexible at all. A prospective tenant signs on the dotted line or goes somewhere else. Negotiation is the name of the game for commercial leases.
• Property Taxes – Residential tenants don’t usually pay any portion of the property taxes for the building they reside in, while it’s common for commercial tenants to pay at least a portion of the property taxes. Your lease should state whether you pay property taxes and what share.

20 Terms You Need to Understand Before Signing Your Commercial Real Estate Lease

1. Exclusive Versus Permitted Use – Landlords often have standardized language around permitted use. You tell them what business you’re in (clothing store, pharmacy, florist), and they allow you to lease premises to conduct it. If you’re in a competitive market, you may also want to add an exclusivity clause restricting other tenants in the building, mall, etc., from using their premises for the same or similar use. Exclusivity clauses can, however, lead to a higher base rent.
2. Base Rent – An amount owed based on the square footage of the space. Make sure your landlord uses your premise’s usable square feet gross square feet in their calculations.
3. Gross Rent Lease – A commercial real estate lease where a tenant pays a single amount covering both base rent and all incidental expenses (see important info on incidental expenses below).
4. Modified Gross Lease – A commercial real estate lease where a tenant and a landlord share certain incidental expenses.
5. Net Lease/Single Net Lease – A commercial real estate lease where a tenant pays base rent plus one incidental expense. In a single net lease, tenants often pay a base rent plus property taxes, though, in some cases, landlords will substitute insurance or utilities. The landlord pays all other expenses.
6. Double Net Lease (NN) – A commercial real estate lease where a tenant pays base rent plus two incidentals – for example, property taxes and insurance. The landlord covers all other expenses.
7. Triple Net Lease (NNN) – A commercial real estate lease where a tenant pays base rent plus property taxes, building insurance and utilities, as well as other operating and maintenance costs. The landlord pays no costs other than for structural repairs to the premises or building.
8. Percentage Rent Lease – A commercial real estate lease commonly used in malls and other multi-tenant retail locations, where a tenant pays base rent plus a percentage of gross sales over an agreed upon minimum.
9. Incidental Expenses – These can include property tax, insurance, utilities, maintenance, common area costsand repairs.
10. Rent Increases – The percentage and frequency of rent increases need to be spelled out in the lease. Tenants often negotiate a cap on the total allowable rent increases over the entire term of the lease.
11. Late Fee – An additional flat fee or a percentage of the monthly rent added to a tenant’s agreed rent if they don’t pay on time.
12. Rent Abatement/Adjustment – A clause outlining if a tenant’s rent will be adjusted or eliminated in the event of property damage from a fire or natural disaster.
13. Lease Term – The duration of the lease. In commercial real estate, lease terms of 3-10 years are common.
14. Notice Period and Break Clause:A clause that allows either party to break or end a lease before the term ends, following written notice. While this may benefit you in some cases, if the landlord has a right to break early, this can create uncertainty for your business.
15. Holdover rent – A rent increase paid when a tenant stays after the lease has expired. This can be up to 250% of the regular rent payment per month. Negotiate this down to around 125% or lower if you can.
16. Option to purchase.This clause states that, at any time during the lease, the tenant has the right to buy the property at an agreed-upon price.
17. Tenant inducements – Incentives offered to encourage a tenant to rent a space. Examples include free rent or a per-square-foot amount of money to assist with leasehold improvements.
18. Leasehold Improvements/Tenant Improvements – Changes made to a leased space to satisfy the needs of a specific tenant. These include painting, flooring or carpeting installation, bathroom renovations, partition or wall construction, shelving, plumbing, electrical or HVAC reconfigurations and more. Regardless of who pays, the improvements revert to the landlord when the lease ends unless otherwise indicated in the lease agreement.
19. Turnkey Improvements/Turnkey Buildouts – Renovations completed by a landlord at a tenant’s request and often used as a tenant inducement.
20. Security deposit.An amount paid by a tenant to the landlord to hold a space until both parties complete all lease negotiations and paperwork. This amount should be specified ahead of time and written into the lease agreement.

Once you and your landlord have agreed to the basics, you’ll also want to iron out how your lease will be transferred in the event you wish to leave the space or if your business closes. Some landlords insist that tenants personally guarantee their lease. This is one demand to nix quickly. Such an agreement means you’re personally on the hook for aspects of the lease for its entire term, even if your business goes bankrupt. Work with your lawyer to negotiate this part of your contract. Ideally, you only ever want your entity or legal business to take on such a risk.

Lastly, ensure your lawyer reviews your entire lease document before you sign.