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Commercial Lease Types
Anyone who has ever rented an apartment is probably familiar with the standard residential lease process – but leasing commercial real estate is an entirely different ballgame. Commercial leases are much more nuanced.
In this article, we will look at the different commercial lease types, the standard terms for each, and the general guidelines around who might use each type of lease and for what purpose.
We’ll also cover how Reonomy can help identify commercial tenants in any market nationwide to help you find tenants looking for a specific lease type.
About Commercial Leases
What is a commercial lease?
A commercial lease is a legally binding agreement made between a landlord (typically, the property owner) and a business tenant.
Sometimes these agreements are negotiated by commercial real estate brokers on behalf of their respective clients, but ultimately, it is the owner who signs as the LESSEE and the tenant who signs as the LESSOR.
At a minimum, a commercial lease should include the following:
- The names of the parties signing the agreement.
- Legal description of the property, including the address and sometimes boundaries.
- Property type (e.g. commercial, industrial, warehouse, etc.)
- Square footage of what’s being rented.
- Term of tenancy.
- Tenant renewal options – including whether they can renew, how frequently they can do so, and under what terms.
- The base rent for the property and how often it is to be paid.
- Whether a security deposit has been collected and in what amount.
- The types of activity that can or cannot occur on the leased premises.
- Whether any improvements will be made to the property as a condition of tenancy, and who will pay for those improvements (often referred to as a “fit out” of the property that considered either “landlord improvements,” or “tenant improvements”).
- What fixtures will be included as part of the lease, which may include sinks, lighting, etc.
What is a commercial lease agreement?
A commercial lease agreement essentially grants the tenant specific rights to the property. The most obvious right is the right to occupy the property.
However, a commercial lease agreement will specify all the details related to those rights – such as the length of the lease period, in exchange for how much money, and specific activities that can occur on the property.
Commercial lease agreements almost always take the form of a written agreement, and are usually quite complex. It is not uncommon for each party to seek the guidance of an attorney before signing a commercial lease agreement.
How often are commercial leases renewed?
Commercial leases 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+ years.
It really depends on the nature of the property, size of the business, and how long the business has been in operation.
That said, commercial leases generally take one of the following forms:
1. 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 this period, and neither party must give the other notice before terminating the lease. The lease simply ends at the end of that period.
2. Automatic Renewal
Some leases are structured to automatically renew after a certain period, unless either party gives advanced notice to the other.
For instance, the owner of a hair salon might sign a yearly lease with an automatic renewal on January 1 each year. The terms of the lease remain in effect (including rent payment), unless the lease is renegotiated.
3. Lease Options
Somewhere between a fixed-end date lease and an automatically renewing lease is a lease option. In this type of commercial lease agreement, the tenant agrees to occupy the premises for a fixed period. At the end of this period, the tenant is given the option to extend their lease for a specific duration at already agreed upon terms.
For instance, a software engineering company might sign a 5-year lease for space in an office building with an option to renew their lease for an additional 5 years once their initial lease expires.
The landlord will typically include a rent escalator so that, if the software company agrees to renew their lease, the landlord will benefit from an increased rent payment. This creates predictability and flexibility for both parties.
Finding Commercial Tenants and Tenant Leads with Reonomy
The lease type on a commercial property can also tell you a bit about the intentions of the tenant.
With Reonomy, you can actually search directly for properties based on who the tenant is (by name), or by tenant type, using NAICS and SIC codes.
During your Reonomy property search, you can visit the Tenant tab to search for commercial tenants by name, or by specific NAICS and SIC code types.
Similarly, let’s say you’ve run a property search by owner name or property address. Even without searching for a specific tenant, when analyzing an individual property, you can visit the Tenant tab to see who the active tenants are in that property, along with the contact information of the individuals associated with the tenant business.
For a bit more context, you can check out the video below or read about Reonomy tenant data.
Types of Commercial Leases
1. Net Lease
A net lease is perhaps the most common form of commercial lease agreement.
With a net lease, the tenant is responsible for a base rent payment plus utilities, insurance, maintenance, and/or other expenses associated with occupying the property.
This is sort of like renting a single-family home: the owner pays the mortgage, but the tenant pays the owner rent and is then responsible for paying for their own utilities, arranging maintenance, and so on.
But net leases come in many forms. Sometimes, the tenant is only responsible for some of the additional expenses. We explain the different types of net leases below.
Single Net Lease
A single net lease, often referred to as an “N” lease, is the simplest form of net lease. With this 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 only reasons a landlord would use a single net lease, instead of a gross lease, is to ensure property taxes are paid on time.
With a single net lease, the landlord collects funds used to pay property taxes and then they can pay the taxes to the city directly.
Double Net Lease
A double net lease, or “NN” lease, makes the renter responsible for the base rent, property taxes, and the cost of building insurance.
With this type of agreement, the landlord maintains responsibility for utilities, maintenance and other related costs. Double net leases are often used in multi-tenant buildings.
This way, the landlord incurs the costs of structural issues on behalf of all tenants. The landlord will generally prorate property taxes and building insurance to each tenant based upon their total leased square footage.
Triple Net Lease
Arguably the favorite among commercial landlords, the triple net lease, or “NNN” lease makes the tenant responsible for the majority of costs, including the base rent, property taxes, insurance, utilities and maintenance.
This even includes standard property repairs associated with the commercial space in question.
For example, if the roof leaks, the tenant in a NNN lease will have to pay for it to be repaired. Given the costs born by the tenant in a NNN lease, the base rent payment is typically lower on a per square foot basis.
NNN leased properties are often owned by investors who prefer to take a more hands-off approach to management.
Bondable Net Lease
A bondable net lease is a variation of the NNN lease, one that places every imaginable risk related to the property on the tenant.
For instance, if the property were to catch fire due to an electrical issue, the tenant would be responsible for the rebuilding effort and would have to continue paying rent to the landlord in the meantime.
Bondable net leases cannot be terminated before the expiration date for any reason. Some landlords use bondable net leases to protect themselves from tenants seeking rent concessions in the event of major structural repairs required under a NNN lease.
2. Full Service Gross Lease
A full service gross lease is one in which the tenant pays a fixed rent each month. The landlord is responsible for covering all other costs, including those related to operations and maintenance.
O&M costs typically include insurance, utilities, management, and state and local taxes. Consider the full service gross lease similar to an all-inclusive resort—pay one flat fee and the rest of the amenities are included.
3. Modified Gross Lease
A modified gross lease is similar to a full service gross lease with one major exception—this lease type makes the tenant responsible for any incremental increase in the building owner’s operational costs beyond the costs calculated in the base year of the lease.
So, if the city increases property taxes, the tenant may be expected to pay a portion of the increase.
4. Percentage Lease
A percentage lease is a type of commercial lease that is most often used by restaurants and retailers.
With a percentage lease, the tenant is expected to pay a base rent – or a minimum amount of rent – in addition to a percentage of the business’s gross income. Therefore, the rent payment is calculated as:
Base Rent + % of Gross Profits = Rent Payment
The percentage must be agreed upon by both parties in advance.
Percentage leases are often calculated using what’s called a “natural breakpoint.” With this type of commercial lease, a natural breakpoint is calculated by dividing the base rent by an agreed percentage.
The percentage rent payable by the tenant is then calculated by dividing the percentage by the annual base rent.
Here’s an example of a percentage lease in action…
The owner of a shopping center signs a percentage lease with a nationally-branded furniture store. The furniture store is the anchor of the shopping center. The furniture store pays an annual base rent of $500,000.
They agree that the tenant will pay percentage rent equal to 5% over the natural breakpoint, in this case: $500,000 / 5%.
This comes out to $10,000,000. If the furniture store has gross sales, for example, of $12,500,000 one year, then the furniture store would pay an additional $125,000 in rent that year. We arrive at this number by taking the amount in excess of the natural breakpoint – or $2,500,000 – and multiplying it by 5%, which equals $125,000.
There are other ways to set percentage leases. For instance, a landlord may agree to set rent solely as a percentage of gross sales.
This practice is more common when using short-term leases or when signing a commercial lease with a startup business that cannot guarantee a certain level of sales initially.
It may also be used when a company has had a few hard years (say, due to a recession) and expects business to pick up significantly in the years to come. In that scenario, the business may not be able to pay a high base rent, but may be able to offer a higher percentage sales as business increases.
Understanding Tenants and the Lease Process
Whatever the case may be, and whichever lease type a commercial tenant is currently locked into, it can be extremely helpful to understand everything about the commercial leasing process and those involved.
With Reonomy, you can very quickly find commercial tenants for office buildings, retail, warehouses, and much more. Search any market nationwide to access owner and tenant contact information, and to start leveraging your understanding of the lease process.
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