It doesn’t matter whether you’re a property owner or a tenant, in either case, signing a commercial lease agreement can seem daunting. You may have signed a residential lease agreement in the past, but commercial leases look much different. In fact, there are multiple forms of commercial lease agreements – which makes understanding these agreements that much more difficult.
In this guide, we provide a comprehensive overview of everything you need to know about commercial lease agreement terms. We look at the most common forms of commercial lease agreements. And we provide an overview of best uses and appropriate times for each lease agreement. We’ll provide definitions for terms that you’ll likely see included in commercial lease agreements. Lastly, for anyone considering signing a commercial lease agreement soon, we wrap things up with FAQs. Embedded throughout this article are a series of case studies. These will provide a sense of how to use these agreements in real-world situations.
Read on to become an expert in commercial lease agreements.
- What is a commercial lease?
- The Most Common Types of Commercial Lease Agreements
- Definitions: Understanding Frequently Used Commercial Lease Agreement Terms
- Additional Rent
- Anchor Tenant
- Base Rent
- Base Year
- Building or “Core” Factor
- Building Class
- Certificate of Occupancy
- Clear-Span Facility
- Common Area
- Common Area Maintenance (CAM)
- Common Area Maintenance (CAM) Cap
- Demised Premises
- Doing Business As (D/B/A)
- Due Diligence
- Eminent Domain
- Estoppel Certificate
- Expense Stop
- Fair Market Value
- Flex Space
- Floor Plan
- Gross Lease
- Hazardous Waste
- Heating, Ventilation, and Air Conditioning (HVAC)
- Holding Over
- Kick-Out Clause
- Leasehold Estate
- Letter of Credit
- Letter of Intent (LOI)
- Liquidated Damages
- Load Factor
- Mechanic’s Lien
- Merchant’s Association
- Minimum Rent (also referred to as “Base Rent”)
- Net Lease
- Non-Competition Clause
- Occupancy Cost
- Partial Taking
- Percentage Rent
- Permitted Uses
- Prime Lease
- Pro-rata Share
- Quiet Enjoyment
- Rent Abatement
- Rent Concession
- Rentable Area
- Right of First Refusal
- Rules and Regulations
- Square Feet
- Structural Elements
- Tenant Improvement (TI) Allowance
- Tenant Improvements
- Trade Fixtures
- Triple Net (NNN) Lease
- Usable Area
- Use Clause
- Use Permit
- Frequently Asked Questions
- What do I need to know about “tenant improvement” (TI) allowances?
- How are security deposits handled in commercial lease agreements?
- When do rents increase in a commercial lease agreement?
- How often are commercial leases renewed?
- If a business is suffering, can I back out of a lease?
- Does a commercial lease agreement become null and void if an owner sells a property?
What is a commercial lease?
Before we begin, let’s start with the basics: what is a commercial lease? A commercial lease is a legally binding agreement made between a landlord (usually, the property owner) and a business tenant. Sometimes commercial real estate brokers negotiate these agreements on behalf of their respective clients. Ultimately, it is the owner who signs as the “LESSEE” and the tenant who signs as the “LESSOR”.
A commercial lease agreement grants the tenant-specific rights to the property owned by the Lessee. The purpose of a commercial lease is to outline the obligations of both the Lessee and the Lessor.
A typically commercial lease agreement
Typically, a commercial lease agreement includes the following:
- The names of the parties signing the agreement.
- A legal description of the property, including the address and sometimes the physical boundaries of the property.
- The type of leased property (e.g., an industrial building, an office building, a retail center).
- The square footage of the leased space.
- The length of the tenancy and whether the tenant has an option to renew the lease. If so, how frequently and under what terms.
- The base rent for the property. This includes some specificity around the frequency of rent payments (e.g., on the first of the month).
- Whether the landlord collects a security deposit, and if so, in what amount.
- A description of how tenants can use a property (for instance, only for business purposes).
- Whether the building owner will make any improvements to the property. If so, on what timeline. Industry professionals refer to this term as the “tenant fit-out”. The owner gives this in the form of an allowance if the owner expects the tenant to perform the work. Or it may specify if the landlord should perform the work on behalf of the tenant prior to occupancy. Later on, we offer more info on tenant fit-outs.
- What fixtures, if any, the lease includes (e.g., sinks, lighting, shelving systems, furniture).
As you can see, commercial leases are quite complex. The bullet points above are just a starting point— these items are the minimum that a lease should contain. Most commercial leases will be much more detailed in practice.
The Most Common Types of Commercial Lease Agreements
There are many forms of commercial lease agreements, each of which has a different purpose to those in the industry. Here are the most common types of commercial lease agreements:
1. The Net Lease
With a net lease, the tenant is responsible for a base rent payment. In addition, the tenant plays all utilities, insurance, maintenance, and other expenses associated with occupying the property. This structure is similar to renting a single-family home. In this case, the owner pays the mortgage, but the tenant pays rent to the owner. What’s more, the tenant must pay all utilities, maintenance, etc. A net lease is one of the most popular types of commercial lease agreements.
There are many forms of net leases. In each scenario, the obligations of the tenant differ. The most common forms of net leases are single net (N) lease agreements, double net (NN) lease agreements, triple net (NNN) lease agreements, and bondable net leases.
Single Net (N) Lease Agreement Terms
A single net (N) lease agreement is the simplest form of net lease. With this lease structure, the tenant pays the rent and the property tax associated with the space they’re renting.
Single net leases are not very common. One of the few reasons owners use single net leases instead of gross leases it helps them ensure timely payment of property taxes. With a single net lease, the landlord collects funds to pay property taxes. Then, the landlord can pay the property taxes directly to ensure payments are on time.
Double Net (NN) Lease Agreement Terms.
A double net (NN) lease agreement makes the tenant responsible for the base rent, property taxes, and the cost of building insurance. A double net (NN) lease agreement structure holds the landlord responsible for paying utilities, maintenance, and other costs.
Double net (NN) lease agreements are common in multi-tenanted buildings. This way, the owner is responsible for all structural issues. Also, the owner doesn’t need to worry about prorating the costs amongst different tenants. What’s more, the landlord generally prorates property taxes and building insurance. Typically, each tenant’s share relates to their total leased square footage.
Triple Net (NNN) Lease Agreement Terms.
Triple net (NNN) lease agreements are the gold standard in commercial real estate. This lease structure makes the tenant responsible for the majority of costs. Specifically, the tenant pays the base rent, property but also taxes, insurance, utilities, and maintenance. This even includes standard property repairs associated with the commercial space being occupied. For instance, if the HVAC system dies on a tenant, an NNN lease agreement holds the tenant responsible for its repair.
In this scenario, the tenant is responsible for so many of the associated costs. So NNN leases often charge a lower rent per SF than either a single net (N) lease or a double net (NN) lease.
Furthermore, triple net leases are a favorite amongst commercial real estate investors who prefer a hands-off approach to ownership. These owners don’t want to bother with a property’s day-to-day management.
Bondable Net Leases
A bondable net lease is a variation of the triple net (NNN) lease agreement. The major difference is that a bondable net lease places every imaginable risk associated with the property on the tenant. For example, if a hurricane or other “act of God” significantly damages the property, the tenant would be responsible for the rebuilding effort. Also, the tenant and would continue paying rent to the landlord in the meantime.
Bondable net leases are also more rigid in nature. Specifically, the landlord cannot terminate or assign them to another party before the lease expiration date for any reason.
According to many industry insiders, bondable net leases are too imbalanced to use in practice. Therefore, while bondable net leases exist, they are infrequent within the industry.
2. The Gross Lease
There are two types of gross leases that commercial real estate professionals use: the full-service gross lease and the modified gross lease.
The Full-Service Gross Lease
A full-service gross lease is one of the most straight-forward leases in which a tenant simply pays a predetermined, fixed rent payment every month. The property owner is responsible for covering all other costs, including those related to operations and maintenance. Operation and maintenance costs (sometimes referred to as “O&M” costs), typically include insurance, utilities, property management fees, and all state and local taxes. We can compare signing a full-service gross lease to staying at an all-inclusive resort: pay one flat fee and the rest of the amenities are included.
The Modified Gross Lease
A modified gross lease agreement is similar to a full-service gross lease with one major exception: a modified gross lease is a type of commercial lease that makes the tenant responsible for any incremental increase in the building owner’s operation costs beyond the costs calculated in the base year of the lease. For example, if a city increases property taxes during a certain year, the tenant in a modified gross lease situation may have an obligation to pay a portion (or all) of that increase.
3. The Percentage Lease
A percentage lease agreement is a type of commercial lease that is most often used by restaurants and retailers. With a percentage lease, the tenant pays a base rent (a minimum amount of rent) in addition to a percentage of the business’s gross income over a period of time. Therefore, we calculate the rent payment as Base Rent + Percentage of Gross Profits, with an agreed-upon percentage by both parties during the lease negotiation process.
Landlords often calculate percentage leases using what’s known as a “natural breakpoint.” We calculate this natural breakpoint by dividing the base rent by an agreed-upon percentage. To calculate the percentage rent payable by the tenant, divide the percentage by the annual base rent.
Example of a Percentage Lease
The owner of a retail center signed a percentage lease with a nationally-branded big-box electronics store. The electronics store is the anchor tenant in that retail center. The electronics store pays an annual base rent of $500,000. They agree that the tenant will pay a percentage rent equal to 5% over the natural breakpoint, which in this case, is calculated as $500,000 divided by 5%. This comes out to $10,000,000.
Say the electronics store has a blockbuster year and does $12,500,000 in sales. In this case, the electronics store would have to pay the owner an additional $125,000 in rent that year. We arrive at this number by taking the amount in excess of the natural breakpoint ($2,500,000) and multiply it by 5%, which equals $125,000.
Percentage leases can be structured in many ways, though. Using the natural breakpoint is just one mechanism. Another common way to structure a percentage lease is by using a percentage of gross sales, absent any base rent. This practice is most common in short-term lease scenarios or when a landlord signs a commercial lease with a new business that cannot accurately predict what their sales will be upon opening.
For example, a restaurateur is opening their first concept in an up-and-coming neighborhood. The restaurateur has just invested significant capital into kitchen equipment and expects most of their initial profits to go toward making payroll – at least until the restaurant gains some notoriety. It will be difficult for the restaurateur to pay a substantial base rent. In this case, the landlord has decided to invest in the business. In exchange for 5% ownership of the business, the landlord agrees to forego any base rent payment in exchange for a percentage of gross sales, say 10%. This is in addition to the 5% the landlord will collect for being a part-owner of the restaurant.
Now, the landlord and the restaurateur are aligned in their interests and can work together to ensure the business succeeds. This may mean the property owner helps to promote the business or offers a higher-than-average tenant fit-out allowance at the outset. It is often the case that landlords will actually earn far more on a square-foot-basis when a lease is structured based on a percentage of gross sales than the landlord would have earned by charging just a base rent. Of course, this is all contingent upon the restaurant being wildly successful – and there is never a guarantee that this will be the case.
Definitions: Understanding Frequently Used Commercial Lease Agreement Terms
Now that you understand the different types of lease agreements, we’ll explore several definitions. These terms are commonly used across lease types, and include triple net (NNN) lease agreement terms, double net (NN) lease agreement terms, single net (N) lease agreement terms, gross lease agreement terms, and percentage lease agreement terms. The definitions for these terms do not vary based on the type of lease agreement in question.
Additional rent refers to the charges to a tenant not included in the base rent, such as common area maintenance (CAM) fees, after-hours service, parking fees, etc.
An agent is any person authorized to act for or in place of another. In regards to commercial lease agreements, a real estate agent represents a landlord or tenant in the lease of a real property. A real estate agent can be a broker or salesperson. It can also be an attorney representing the owner or tenant.
Alterations refer to any substantial change to real estate, especially to the premises and usually not involving an addition to or removal of the exterior of the building’s structure.
An anchor tenant is a large tenant that draws traffic to the site. The term “anchor tenant” is most often used in retail leasing, such as a grocery story that “anchors” a shopping center and draws people there every day. A large employer can also be an anchor tenant in a commercial building.
Arbitration refers to a non-judicial dispute resolution process that involves a hearing and determination of a disputed issue by one or more neutral third parties whose decision is binding.
Assessments are the imposition of a tax, fine, or other amount levied against a property, commonly by the government. An assessment can also be issued to tenants by a property owner, depending on the type of lease that has been signed. This is typically referred to as a “special assessment” and will be prorated to tenants based on their occupiable square footage. For example, the landlord may impose a special assessment to tenants if a major structural repair is needed and the tents have signed a net lease.
An assignment refers to the transfer of an interest (e.g., a leasehold interest) in real property. In practical terms, it is often said that a tenant who wants to end their lease early will assign their lease to a third party. That third party must then fulfill all obligations of the original tenant for the duration of the leasehold period.
The base rent is the minimum rent due under a standard commercial lease agreement. Additional rent may be required, in addition to the base rent, depending on the lease structure.
The base year is usually the first year of a lease to which future operating expenses are compared for the purpose of calculating expense increases.
Building or “Core” Factor
Building factor, oftentimes referred to as “core” factor or “load” factor, represents the percentage of the difference between the usable and the rentable square footage of a building. This calculation makes an accommodation for unusable (and therefore, un-rentable) square footage, such as building lobbies, bathrooms, corridors, etc. The building factor can be calculated at both the building level or on a floor-by-floor basis.
The build-out refers to any work required to make the premises ready for the business to operate out of the space on the first day of their lease agreement.
Commercial properties are often classified as Class A, Class B, or Class C. Although there is no universal definition for these classifications, Class A properties are generally the newest and highest quality buildings. Furthermore, they are typically in premier locations with credit-worthy tenants. Class A properties are usually professionally managed and offer several amenities. In comparison, Class B properties tend to be a little older and may not be as well-located, but they still have strong management and tenants. In addition, Class C properties are the bottom-tier properties that are usually older. What’s more, these properties may be located in less desirable areas may need renovations. In general, Class A properties generally command top rents, with Class B and Class C properties to follow.
Certificate of Occupancy
This refers to the legal notice indicating that a building complies with all local zoning and building ordinance, and is ready for a tenant to occupy.
A clear-span facility is a building that does not have any vertical columns running through the rentable space. The clear-span width is the space between the columns, and is most frequently found in warehouses, industrial facilities and parking garage structures. Think of a clear-span space as one that is otherwise clear of columns, beams and other infrastructure.
Areas of the project available for use by all tenants on a non-exclusive basis, such as hallways, lobby areas, parking lots, courtyards, etc.
Common Area Maintenance (CAM)
The common area maintenance (CAM) expense is an amount charged to tenants on top of the base rent as additional rent. It is mainly used to cover the cost of maintenance fees for work performed to maintain the common areas of the property. CAM fees are assessed to tenants on a prorated basis depending on occupiable square feet.
Common Area Maintenance (CAM) Cap
The maximum amount the tenant can be charged for its share of common area maintenance expenses.
The taking of private property by a public agency through the right of eminent domain for a public purpose upon the payment of just compensation by the government agency to the property owner. Situations of condemnation are rare, but do occur. For example, a municipality may need to take a property by eminent domain in order to allow for a new highway off-ramp to be extended into a community.
Anything of value, given or promised, by one party to include another to enter into a contract. Consideration can come in the form of money, personal property, or a promise to do or not do something.
An entity is said to be in default of a commercial lease agreement when they have failed to fulfill by the full terms and conditions of said lease agreement. For instance, if a tenant fails to pay rent to the owner on time, they would be in default of their lease.
The term “demise” means to transfer or convey. In commercial lease agreements, it refers to the landlord conveying the premises to the tenant, thereby creating a leasehold estate, or the demised premises.
Doing Business As (D/B/A)
This is a term often used to refer to the name of a business in its operations that differs from the registered legal name of the business. For instance, one might say “Sally Jones Company, doing business as SJ Properties, LLC” to denote the difference.
The process of examining and investigating a property by or for the potential tenant, lender or purchaser of a property. Failure to exercise due diligence may sometimes result in unanticipated costs or liabilities.
An easement is a publicly-recorded legal agreement that gives one party the authority to use another person’s property for a specific purpose. The current owner maintains ownership of that property, but grants use to the other party for a period of time (sometimes indefinitely). For example, a property owner may provide another owner with an easement to use a strip of land as a driveway if there was no space on his own property for that driveway.
Eminent domain is the power of government to take private property for the sake of public benefit. For instance, a utility company may need to take a strip of land from a private land owner in order to extend gas service to a new development project. Eminent domain proceedings are typically rare, and when evoked, the public entity taking the land must provide just compensation to the owner in exchange for the land.
An estoppel certificate is essentially a signed statement that certifies certain facts to be true. In commercial real estate agreements, it mostly verifies the terms and conditions and the current status of a tenant’s lease.
Commercial real estate agreements use the term exclusivity to prohibit an owner from leasing to another tenant with similar business uses. Exclusivity provisions are common in retail leasing situations. For example, a fast-casual burger chain might require that an exclusivity agreement be part of a lease prior to moving into a new outdoor shopping center. This means that the landlord cannot rent space to any other fast-casual burger restaurants that may present competition to their business.
In the context of commercial lease agreements, “execution” sometimes refers to the act of signing a legal document (e.g., “execution of the lease agreement”. Execution also refers to the act or process of performing any duties or obligations under a signed lease.
The maximum amount a landlord will pay for certain operating expenses.
Fair Market Value
The price a buyer is willing to pay, and a seller is willing to accept in the open market in an unrelated, arms-length transaction. In the context of commercial lease agreement terms, this is often used in connection with describing the method for determining the value of rent, such as fair market rent.
Landlords may use fair market value when the lease contains an option-to-purchase provision. In this case, the landlord gives the tenant the option to purchase the property at a certain moment in time (or at any time during the duration of the lease agreement) for fair market value.
Flex space is a building classification that indicates the space is useful for multiple purposes (i.e., flexibly). Most flex space properties contain some combination of office, industrial and/or warehouse space. A good example of flex space is a car showroom that needs a big floor to display vehicles and office space where employees can work and host meetings. Flex space typically has wide clear-spans and high ceilings.
A drawing that shows the design of a building or room from above. Commercial lease agreements usually include these to indicate which areas the tenant will be able to occupy.
Fit-out typically refers to activities making a commercial tenant interior space suitable for occupation. Often, a tenant’s own contractor does fit-out construction, as opposed to the landlord’s construction company.
As noted above, a gross lease is a type of rent structure under which the tenant pays rent that is all-inclusive. The landlord covers all other occupancy expenses such as utilities, taxes, insurance and maintenance.
A guaranty is the written promise of an individual to pay the debt of another. In a commercial setting, a guaranty is typically the promise of an owner or officer of a corporate entity to pay the debt of that corporate entity should it default on its obligation.
Hazardous waste, often referred to as hazardous material or hazardous substances. This term refers to dangerous substances that, because of their physical or chemical composition, quantity, or concentration may harm human health or the environment.
Heating, Ventilation, and Air Conditioning (HVAC)
The HVAC system refers to the system that is used to provide heating and cooling services to a building.
When a tenant continues occupying a premises after the expiration of the original lease term, this is referred to as holding over.
With a real estate indemnity agreement, one party is pledging to protect another (“indemnify”) from any kind of financial loss or from a lawsuit of some kind.
A commercial lease agreement term that allows a tenant or landlord to cancel the lease after a certain time has passed or certain conditions have not been met.
A person or entity (often called a Lessor) that owns real property and leases it to a tenant (often called a Lessee).
A legally-binding contract under which an owner of real property grants to another the right to use the real property in exchange for rent or other consideration. In commercial real estate, there are multiple types of leases, including a single net (N) lease agreement, double net (NN) lease agreement, triple net (NNN) lease agreement, gross lease, and percentage leases.
Ownership by a tenant of a temporary right to occupy and use a property for the duration of a lease in exchange for rent.
Another term for a tenant.
Another term for landlord or property owner.
Letter of Credit
A letter issued by a bank to another bank to serve as a guaranty for payments made to a specified person or entity under specified conditions.
Letter of Intent (LOI)
In terms of commercial lease agreements, a letter of intent (LOI) is used to describe a document outlining certain agreements between parties (usually the business terms of the deal) for the agreements are finalized in a formal, comprehensive lease or sales agreement. For example, a LOI might state that a tenant is willing to occupy a property for X amount of money for X period of time, but only if the current owner obtains a variance needed in order for the business to operate out of this premises.
A monetary encumbrance on a specific property (real or personal) making the property security for the satisfaction of a debt, or the performance of an obligation. A mortgage is the most common form of lien placed on a property.
A clause in a commercial lease agreement which stipulates a set dollar amount of damages or a calculation for determining such damages, to be collected by one party upon a breach of contract by the other party.
Usually found in commercial lease agreements pertaining to office buildings, the load factor refers to the percentage of non-rentable space (e.g., the lobby, restrooms, corridors, elevators) charged pro-rata to each tenant on the basis of rentable square footage.
A mechanic’s lien is a type of lien placed on a property for failure to pay labor or materials needed to repair or improve a property. Specific forms of mechanic’s liens include a construction lien (for labor) and materialmen’s lien (for materials).
Mediation is a non-judicial dispute resolution process where a neutral third party assists disputing parties in reaching a mutually-agreeable solution.
In retail shopping centers, an association of merchant-tenants formed by the developer or owner to finance the promotion of the center as a whole.
Minimum Rent (also referred to as “Base Rent”)
In the context of commercial lease agreements, the minimum rent refers to the base, fixed rent applicable for a certain period. Minimum rent can be subject to adjustment periodically, based on negotiated terms.
A legal instrument that makes specific real property security for the repayment of a loan, or for the performance of some other obligation.
A property occupied by, or leased to, more than one tenant.
As described above, a lease in which the tenant is responsible for direct payment of property expenses which may include taxes, insurance, and maintenance costs in addition to rent.
A clause either prohibiting a landlord from leasing space to another tenant engaged in the same or similar business as the tenant signing the lease, or prohibiting a tenant from opening multiple locations within a certain radius of the existing location. For example, a landlord leasing to a mattress retail store may include a non-competition clause that the tenant cannot open another mattress retail store within a 5-mile radius of that location.
The total cost of leasing space, including minimum rent, percentage rent, taxes, insurance, maintenance, parking fees, advertising fees, merchant association fees, and any other charges assessed on a periodic basis.
A right given in exchange for consideration (i.e., something of value) by a landlord to a tenant to buy or lease the property under specific terms and conditions for a specific period, without obligating the tenant to exercise the right. There are two common forms of options in commercial lease agreement: (a) an option to extend; and (b) option to purchase.
Landlords use an option to extend when a tenant has signed a lease for a certain period of time (say, 5 years) and then has an option to extend their lease for a certain number of years (say, 5 more years). It is common for a tenant to have multiple options to extend when signing a lease (say, three 5-year options). An option to purchase refers to a tenant having the option to purchase the property during the lease period, or at the end of the lease period, for a predetermined price, such as fair market value.
Laws passed by governments (either cities or counties) that property owners and their tenants must abide by (such as noise ordinances).
The condemnation of only a portion of an entire property by a government agency for public use and just compensation. For example, condemnation of a strip of land abutting a parking lot may be used for road widening purposes.
Percentage rent is a common form of commercial lease agreement in the retail sector. The landlord charges rent to a tenant is based upon a percentage of their gross sales.
Uses of a specified property that complies with local zoning ordinances.
In commercial lease agreements, possession describes the giving or taking of occupancy of a premises. Possession of a property can occur before, at the same time, or after the commencement date of the lease or commencement of rent.
The actual space in a building the landlord leases to a tenant for its exclusive use.
Arises in subleasing situations and refers to the original lease of the subject premises to distinguish it from the sublease. We sometimes refer to a prime lease as the master lease.
The proportion of costs allocated to a tenant in a multi-tenanted property. Typically, pro-rata share allocates how much a tenant pays for taxes, insurance, and common area maintenance expenses. And it is usually equal to the percentage that a tenant’s rentable square footage bears to the total rentable square footage of a property. For example, say a tenant occupies 5% of a property’s total leasable square footage. That tenant may have an obligation to pay a pro-rata share (5%) of all other expenses.
Land, and any improvements on it (such as the buildings), is considered “real” property. Everything else (such as the furniture within the building) are considered “personal” property.
The right of a property owner, or a tenant, to use the property without interference from another party. Tenants get quiet enjoyment as long as they comply with all the terms and conditions of their agreement.
In the context of commercial lease agreements, recapture is the right of a landlord to take back space from a tenant. This happens when a tenant doesn’t meet performance standards specified in the lease for sales volume, rent, or other reasons.
Filing or recording a legal document with the appropriate recording office (e.g., the Registry of Deeds) to make it of public record. When a recording document, it gives notice to interested parties of the existence of an encumbrance affecting the subject property. It is often said that deeds or mortgages are recorded. At that time, the recorder gives notice of a transfer of property or lien on the property, respectively.
In a commercial lease agreement, relocation refers to the negotiated right of the landlord to move a tenant from one location to another within a building or project.
Consideration paid for the use and occupancy of the property.
A release of a tenant’s obligations to pay rent for a period under certain specified situations, such as a casualty event or an act of God.
A period of free rent given to the tenant by the landlord.
The square footage of a property for which the landlord charges rent. Compare to “usable area”.
Right of First Refusal
As a commercial lease agreement term, this refers to the negotiated right of a tenant to match any bona fide offer received by a landlord to lease or sell the demised premises.
Rules and Regulations
Often an exhibit to a lease or document incorporated by reference in the lease describing important operational aspects of the building or complex, such as hours of operation, noise control, parking regulations, delivery procedures, trash removal, etc.
A property leased to only one tenant.
The unit of measurement used to calculate the floor area of a space. For example, if a space is 20 feet wide and 100 feet deep, it would have an area of 2,000 square feet (20 feet x 100 feet = 2,000 feet).
The parts of a building constituting its “shell,” including the foundation, floor, walls, roof structure, and roof, sewer lines, water mains, and utility systems from the street to the building.
A lease where the original tenant sublets all or a portion of the leasehold interest to another tenant (referred to as the “subtenant”) while still retaining a leasehold interest in the property.
Subordination refers to moving a claim or right against a property to a position of lower priority. We often refer to this in the context of mortgages. In this case, a lender agrees to subordinate the first mortgage lien to a second mortgage lien.
The substitution of one party for another concerning a right or claim. In commercial lease agreements, this term arises in insurance clauses in reference to the concept under which an insurer pays a loss under an insurance policy and is entitled to all the rights and remedies of the insured against a third party concerning any covered loss.
A person or entity that occupies and holds the right to possess real property owned by another. This is another term for lessee.
Tenant Improvement (TI) Allowance
An amount, negotiated in the lease, that a landlord is willing to give a tenant to make improvements to the premises. Landlords typically recover the tenant improvement (TI) allowance from the tenant through the rent over the lease term.
Modifications to the leased property to accommodate the specific needs of the tenant, such as interior walls, flooring, light fixtures, doors, window treatments, etc. Tenant improvements can be inside or outside of the premises and can be paid for by the tenant, landlord, or both. The costs of these are typically negotiated during the initial leasing process.
The length of time during which the lease is in effect.
Ending or canceling a lease for any reason.
Personal property affixed to real property by a tenant. These are necessary to conduct its business, but and are removable by the tenant at the end of the lease. This could include shelving units, for instance, that a warehouse operator must install to run its business.
Triple Net (NNN) Lease
As described above, the most common form of commercial lease agreement in which a tenant pays rent plus all property expenses, leaving the landlord with an amount “net” of such property expense costs.
Uniform Commercial Code, Form 1. This is a standardized, recorded form of financing statement that provides notice of personal property pledged as security.
The actual square footage available for tenant’s use, which is different than “rentable area”.
A use clause limits how the tenant can use the rented space. The limitations can be as broad as what business can be conducted there. On the other hand, the limitations can be as narrow as what specific services or products can be offered. Or they might be as nebulous as the quality level of a business operation.
A permit obtained from the local planning department (at the city or county level) that allows an owner or tenant to use a property for a purpose not permitted under the standard zoning ordinance. A tenant may insist that they secure a use permit prior to finalizing any long-term lease agreement.
The process of determining the value or estimated value of a property.
Giving up or relinquishing the privilege to enforce a right.
Frequently Asked Questions
Here are some of the most frequently asked questions amongst those interested in understanding how commercial lease agreements work in practice.
What do I need to know about “tenant improvement” (TI) allowances?
Landlords will generally provide tenants with what’s known as a “TI” allowance, which are funds provided by the landlord to the tenant to build out new space or alter/renovate existing, previously occupied space for the new tenant’s particular use.
There are several factors that influence the size of the allowance a landlord will commit to build/improve/renovate tenant spaces. These include tenant size and creditworthiness, lease rate, lease term, market conditions, and competition.
As a general rule of thumb, landlords typically invest in TI projects for larger and more creditworthy tenants with longer lease terms.
Typically, Landlords also consider the type of TI. Down the road, other tenants may utilize certain property investments. Some examples include elevators, a new roof deck, improved electrical infrastructure. These are different than investing in niche TI projects geared towards very specific types of tenants.
How are security deposits handled in commercial lease agreements?
Landlords can collect a security deposit prior to or at the start of a lease term. This security deposit must be held in an escrow account. The landlord can only touch this money if a tenant damages the property. Also, if a tenant fails to fulfill their monetary obligations per the lease agreement. Such things include failure to pay rent, taxes or insurance.
Security deposits in commercial real estate, unlike those in residential real estate, have very little regulation. This gives landlords the freedom to charge what they deem necessary and to use the deposit as they see fit. It even applies to collecting interest on the deposit.
In general, commercial real estate security deposits are fully refundable and aren’t used to repair normal wear and tear. If no damage occurred during the lease term and the tenant paid rent on time, the tenant expects the landlord to refund the entire deposit. A tenant usually receives their deposit within 30 or 60 days of the lease expiration.
Cost-wise, security deposits can run the gamut. It often depends on whether the tenant has a gross lease agreement or net lease agreement. It also depends on factors such as TI allowance and tenant credit. Those with higher TI allowances tend to have higher security deposits. This is due to the money the landlord invests on the front end. Meanwhile, the creditworthiness of a tenant plays a major role in the security deposit’s amount. usually, established companies with strong financials and a proven history of on-time payments have lower security deposit requirements. It’s even possible for large, established multinational corporations to pay no security deposits.
When do rents increase in a commercial lease agreement?
Rents will not usually remain static under a lease where that lease exceeds 3 to 5 years in length. After that period, commercial lease agreements will typically include some sort of rent escalator. The rent escalator might be a set increase in rent or a percentage increase. In the case of a percentage increase, landlords often tie that increase to some formal index. Examples of indexes are the Retail Price Index (RPI) and the Consumer Price Index (CPI).
Commercial lease agreements tied to an index should specify whether that rent increase will be compounded. This occurs when applying the increase in the index year on year. A more favorable approach to tenants stipulates that the rent should at any given year only increase according to the increase in the index. The rent would be calculated by reference to the index in the month immediately before the start of the lease term. This is in comparison to the index figure immediately before the relevant anniversary of the term in question.
An Alternative to Indexes
An alternative way (and arguably the most common way) to increase the base rent is a lease being to rent review. Rent review is when the rent adjusts based on a review and valuation of the lease in the open market.
In the case of long-term leases subject to rent review, most will stipulate that base rent cannot go down. Even if the market deteriorates, rents stay the same. Instead, the rent will only increase if the value of the lease on the open market has since increased. Most leases include a termination clause. This allows a tenant to back out of a lease upon rent review. But only if the adjusted base rent becomes too high for the tenant to bear.
Tenants often use this clause as a bargaining chip with a landlord who otherwise worries about vacancy if the tenant ends the lease. For example, a landlord might initially decide to increase the base rent by 10%. The tenant decides this is too much to bear and does not want to renew the lease. The landlord has to make a decision: forego the 10% increase or face a potential vacancy? A property that sits vacant for several months may be much more costly to the landlord than keeping rents even.
How often are commercial leases renewed?
Commercial lease agreements can vary in length. Some leases run month-to-month, which is particularly true when dealing with smaller commercial properties.
Others have lease terms for 30+ year periods. However, these tend to be large retailers or national chains with a proven track record in the industry.
Most commercial leases have one of the following structures:
- Fixed End Date: a lease with a fixed end date gives each party certainty around when the tenancy will end. All terms of the lease remain the same during the period. And neither party must give the other notice before terminating the lease.
- Automatic Renewal: Some commercial lease agreements automatically renew after a certain period. This happens unless either party gives the other advanced notice. For instance, the owner of a bakery might sign a yearly lease with an annual automatic renewal on July 1. The terms of the lease remain in effect, including rent payment, unless the parties renegotiate the lease.
- Lease Options: Somewhere between a fixed-end date and automatic renewal is a lease option. In this type of commercial real estate lease agreement, the tenant agrees to occupy the premises for a fixed period. At the end of this period, the tenant can extend their lease for a specific duration at already agreed-upon terms. We call this exercising their option.
If a business is suffering, can I back out of a lease?
It depends. The commercial lease agreement should specify whether the tenant has the right to sublet the premises or terminate the tenancy. If the lease contains a termination provision, it should specify when and why a tenant can end a lease. It also indicates how much notice a tenant must give the landlord prior to terminating the lease.
Does a commercial lease agreement become null and void if an owner sells a property?
No. Most leases will remain in full force and effect under the new ownership unless otherwise specified. It is important to refer to the original commercial lease agreement for clarity. The commercial lease agreement should address landlord assignment.