Commercial Leases
| By Eric Ramshaw • Commercial Real Estate Consultant | Please note that information in this article may be time sensitive and specific to the date it was originally published. Please contact the author for updates to this information. |
Letters of Intent
The potential parties to a lease may initiate a formal lease proposal by first submitting a letter of intent (LOI). This letter briefly outlines the proposed terms of a lease including the amount of space involved, the usage, rent and term. Assuming the recipient of the LOI accepts the basis, a formal lease is then prepared reflecting the terms indicated in the LOI. This document also includes the detailed, far more specific lease terms, which are negotiated between the parties.
Rent Liability
When a lease is signed, the business owner(s) becomes liable for the rent over the entire period of the lease. For example, with a five-year lease of $3,000 per month, the total amount of the lease for which the tenant becomes liable would be $180,000. Therefore, should the tenant vacate the premises after 2 years, the balance of $108,000 is still due. Lessees frequently are under the misunderstanding that if they sub-lease the property, theyʼre no longer liable. In actuality, the opposite is usually the case. The reason for this misconception is that the sub-lease payment may not be paid and any personal guarantees by the lessee will, if necessary, be used by the landlord to satisfy payment.
Types of Leases
There are gross leases, triple net leases and those in between. The latter are often described as modified gross. A gross lease includes all of the expenses incurred by the landlord which are incorporated into the rent figure. The triple net (NNN) lease is comprised of a base rent to provide a return on investment for the property owner. In this arrangement, operating expenses usually are a separate charge. The operating expenses may be known as common area maintenance (CAM) charges. These costs are usually estimated for the whole building and allocated to tenants on a percentage use basis. At the end of each year, the landlord typically provides a summary of actual expenses and an adjustment is made for any discrepancy. A new estimate for the forthcoming year is then prepared using actual figures.
CAM items usually include real estate taxes, property insurance (for the building to be occupied) and items such as landscape and parking lot maintenance, utilities, pest control, common elevators, janitorial, lighting and security etc.
Both gross and base rents may be subject to variations. One frequent such variation is the use of escalation clauses. These provide for an annual percentage increase in the base rent. Alternatively, the increase may be based on Consumer Price Index fluctuations.
In retail leasing itʼs not unusual to have a base rent with additional rent becoming due once a certain level of gross sales has been reached by the tenant. An example may be that when gross sales reach $1,000,000 then an additional charge of 5% of sales over that amount will be charged as additional rent.
Lease Restrictions
There are a number of restrictions incorporated into leases. The most common relates to specified usage of the premises. Others may restrict operating hours and possibly provide for additional charges for electricity if air conditioning is used outside of normal office hours. In retail premises, the landlord may require a minimum number of operating hours. Signage may be limited to conforming sizes and colors to achieve a uniform appearance or comply with city regulations.
Usable Space vs. Rentable Space
Where there are several tenants in one building, the actual number of square feet to be occupied is usually less than the amount of space for which the lessor charges. This arises because the building may contain stairwells, elevators, shared bathroom facilities, etc. The space occupied by these items is not directly occupied by individual tenants but nonetheless theyʼre provided for the use of the tenants-at-large and the cost of providing them must be recouped by property owners. In consequence, a percentage of the whole is allocated to individual tenants.
Other Considerations
Heating, Ventilation & Air Conditioning: It behooves tenants to closely review the lease terminology as regards HVAC. Tenants are usually responsible for HVAC maintenance contracts and/or repairs. A fair landlord will provide at least an initial guarantee period for an older system.
Lease Review
Experienced real estate agents may have valuable input as to lease terminology. However, itʼs critical to understand that unless they also are legally qualified to practice law, then itʼs advisable to have an experienced commercial real estate attorney review such documents.
Eric Ramshaw is a broker associate with Coldwell Banker Commercial Benchmark in Jacksonville.
He can be reached at eramshaw@cbcbenchmark.com or (904) 421-8528
