As a business, you should know the ins and outs of leasing commercial real estate. Knowing how to negotiate effectively with a landlord will help you avoid getting ripped off and will also aid you during the negotiation process.
There are three forms of commercial leases:
- Full-service leases
- Net leases
- Modified gross leases
In this article, we’ll be breaking down the steps of finding, negotiating, and signing a commercial lease as you search for commercial space for rent.
1) Setting your property parameters
Before you start signing contracts, you should have a general idea of your ideal property parameters. There is a massive range of commercial property for rent out there, thus setting predefined parameters will help you significantly limit your search.
You should have an idea of your ideal building size, ideal customer, accessibility, budget, and property type/zoning. Setting and understanding these parameters will ensure you find commercial real estate that’s perfect for your needs.
Now we’ll exam each of these parameters in-depth to gain a better understanding of each.
No matter what type of business you’re running, one of the most important parameters you should focus on is your ideal customer. Examples of businesses that fall into this category are restaurants and retail stores. Identifying where your ideal customers congregate will help you pick the perfect location to set up shop.
Let’s say you run a tire business. Setting up along a major road will put you in the optimal position to become more visible to drivers who are in need of a tire change.
When it comes to office leasing, you should search for a location that’s more suitable for your employees. How easy is the location to find? Is there accessible parking? Etc.
When you’re on the hunt for office space for rent be mindful of zoning laws. All commercial real estate has been zoned for a specific use. For example, certain commercial buildings have been zoned for retail stores while others have been zoned for use by restaurants.
Therefore, if you’re attempting to open a warehouse, you won’t be able to lease a commercial space zoned for a grocery store. It would behoove you to know the type of zoning your business needs. Conduct thorough research on your local zoning laws to stay ahead of the curve.
Buildings come in all shapes, sizes, and layouts. The best way to go about determining the size of your desired office space for lease is to calculate either the total number of people you plan to employ or the maximum number of customers that you can accommodate at any given time.
Always be aware of your maximum budget. Recognizing your limitations will allow you to avoid wasting your time searching for offices for rent that don’t fall within your budget. Typically, your maximum budget is determined by the size of your business as well as its performance.
Easy accessibility is essential for every business. Let’s say you run a restaurant. Do you have adequate seating for your customers? Do you have sufficient parking? Do you have a ramp for disabled individuals? Are you located in an area with ample vehicle and foot traffic? Answering these questions will give you a general idea of how truly accessible your commercial space is.
2) The various types of commercial leases
There are three types of commercial leases you should familiarize yourself with:
- Full-service lease
- Net lease
- Modified gross lease
When it comes offices for lease, the most common type of commercial lease is a full-service lease. With a full-service lease, the rent is all-inclusive. This means the landlord takes care of all property related expenses. Such expenses include insurance, repairs, utilities, janitorial services, and property taxes.
Full-service leases are easily the best deal for the tenant because all costs are upfront. Therefore the tenant can forecast monthly expenses without the fear of hidden fees upsetting their budget.
With a net lease agreement, the tenant pays a lower annual rent when compared with a full-service lease. As a result, the landlord can also charge what are considered to be “usual costs.” These include common area maintenance items (CAMS), property insurance, and property taxes.
There are three types of net leases: single, double, or triple net lease.
With a single net lease, the tenant pays a pro-rata share of the building’s property taxes on top of the rent. With a double net lease, the tenant must add on property insurance in addition to the property taxes and rent. With a triple net lease, the most landlord-friendly lease, the tenant must pay property insurance, property taxes, and CAMS.
The primary advantage of a net lease is the fact that the rent is cheaper overall. However, the tenant takes on the responsibility of covering the maintenance fees of the property. In most cases, these fees will be added to the rent on a monthly basis.
Modified gross lease
If you’re not interested in either a full-service lease or a net lease, you can meet in the middle with a modified gross lease. With a modified gross lease, tenants pay for CAMS, property insurance and property taxes. What makes the modified gross lease so unique is these expenses are paid along with the rent in one lump sum.
The primary advantage of a modified gross lease is that the price is fixed and you won’t have to contend with any hidden fees. Even if certain expenses increase (such as CAMS or insurance), your rent will always remain the same. Also, when you sign a modified gross lease, the landlord covers the janitorial and utility costs.
3) Find the right type of commercial property
There are a variety of factors you need to keep in mind when you’re searching for the right type of commercial property.
Anchor tenants – sometimes commercial properties that have multiple units will have an anchor tenant. The perfect example of an anchor tenant would be a dental office located within a shopping complex. Find out about any possible anchor tenants before signing a lease, because the landlord might be able to back out from the other leases associated with the property if the anchor tenant leaves.
Location – ensure you’re in a commercial space that either accommodates your employees or your customers.
History of the landlord – knowing the history of your landlord will give you an idea of what to expect during your interactions with one another. Often times commercial space lease agreements span multiple years, so it’s best to know as much about the landlord as possible.
Amenities and services – what type of amenities and services does the commercial space offer? Examples include utilities, dining options, Wi-Fi, loading bays, outdoor space, etc.
Doing a walkthrough of the commercial space
When you’re searching for a commercial space, you should always look for multiple locations. That way, you’ll have more options when you enter the negotiation phase. On average, you should identify at least 4 -10 commercial spaces. This will give you a ratio of the average price that you should come to expect of the commercial real estate in a specific area.
A great idea is to identify around 8 – 10 commercial spaces that fit your criteria and then limit that number down to 4 -5 picks. Once you’ve done that you should do a physical walkthrough of those locations to narrow your choices even further.
In the commercial real estate business, physical tours of a property are customarily referred to as “technical property reviews.” It’s highly recommended that you walk the property with an experienced contractor because the property may need what’s known as a lease buildout –improvements and additions that are required to be added to the commercial space.
Lease buildouts can be essential to the negotiation process because you may be able to get the landlord to either fully or partially cover the expense of any repairs or additions. It all comes down to negotiating the lease buildout into your lease once you’ve entered the negotiation phase.
Of course, that leads us into one of the most critical aspects of this guide — negotiating the terms of your commercial lease.
4) Negotiate the terms of your commercial lease
When you have located the commercial space that fits your criteria, it’s now time to move on to the negotiation phase. Formally, you should request the terms of the lease in writing. This information will be communicated to the broker of the landlord.
Next will come your business letter of intent (LOI) which states your offer or counteroffer. You can use your LOI to communicate to the landlord why you’re the best choice for a particular piece of property. You should make your LOI as convincing as possible because it’ll make you more attractive to the landlord, especially when you’re competing for a commercial property that’s especially competitive.
This is what your letter of intent should include:
- The number of years you’ve been in business
- A statement with your intent to lease
- The terms you wish to propose
- A list of your products and services
- Your pricing
- A description of your business
Common commercial lease terms you’ll encounter
We’ve discussed the various types of leases, but no matter what lease you end up signing, you’ll run into a number of similar terms. Let’s take a look at a few of the more common terms:
- Rent abatement – the tenant will either not have to pay rent or pay a reduced price if there is any damage to the commercial property until the damage has been fixed.
- Length of lease – on average a commercial lease can range anywhere from 3 to 10 years. Businesses will often find shorter leases are advantageous because it lessens future financial burdens which allows for great flexibility.
- Capital expenditures – this term makes reference to the party who’s responsible for specific expenses such as maintenance and repairs amongst other costs associated with the building.
- Lease build-out credits – a representation of the tenant’s ability to conduct leasehold improvements in their rental property which will then be charged to the landlord. The only improvements that fall under this category are the ones that are required for the business to operate successfully. To cover the cost, the landlord will either pay out of pocket, reduce the rent, or reimburse the tenant.
- Deposit – the vast majority of leases require a deposit. Deposits are typically fully refundable and serve to protect the landlord from a tenant who does not pay their rent or from those who cause significant damage to the commercial space.
- Termination clause – this is a clause in the lease that allows either the tenant or the landlord to terminate the lease under specific conditions. Termination clauses are both good and bad because they allow the tenant to terminate a lease when needed, but the landlord can easily do the same.
- Use clause – this is a clause that defines the type of business that can use a particular commercial space. For example, you can only open a restaurant in a space that has been zoned for restaurants.
There are many terms for commercial leases. Do your homework and know what terms are available to you so that you can identify all of your options.
What it all comes down to
When it comes to leasing a commercial space, there are a great many factors you have to keep in mind. Ultimately, commercial leases can work to your advantage if you know what factors to look for. Do your homework. The more prepared you are, the more likely you’ll end up with a good deal that will benefit your business for the long-term.