How to Lease Commercial Real Estate: A Quick Guide
Before you start your search for commercial property, there is some homework to do. Think about who your customers are, how important visibility is to your business, what your budget is, what amenities would be appealing to your employees, and how large the space should be to accommodate any planned growth.
For example, New York City has a very robust transit system and the most popular way for commuters to get around is the subway. If this is a consideration for your office, there are 472 stations that serve the boroughs of Manhattan, the Bronx, Queens, and Brooklyn. Between the subway and bus systems, you’ll have plenty of options to choose from if this proximity is near the top of your wish list.
If you’re looking at office space to lease, plan for at least 100 square feet per workspace per employee. Restaurant and retail guidelines differ and average 15 square feet per customer at full capacity. Medical office floor plans have even more criteria based on the type of services offered.
Research the landlord too, after all, you’ll be in a relationship for years to come and you should feel comfortable doing business with this person. Who are the other tenants? Do they complement your business? Take the time to think about your business needs and use this guide to help you learn how to rent commercial property.
Different Types of Commercial Leases
When it comes to leasing commercial properties, there are a few types of lease agreements used. As you understand what each type of lease entails, you’ll discover the one that works best for your business. One thing you want to make sure of, is to take the time to review each part of the contract. Even though there are standard terms used in a lease, there are several other clauses that exist, such as an escalation clause. This gives a landlord flexibility to increase rent to cover his expenses.
The bottom line is, do your due diligence and use the expertise of your broker if you are working with one. Run the numbers for each scenario and take into account your current financial status and risk level.
Modified Gross Lease
A modified gross lease, or modified net lease, is a type of real estate rental agreement where the tenant pays a base rent along with a portion of the operating expenses. This could include utilities proportionate to the size of their office space, a share of common area expenses, or a percentage of property taxes and insurance. The landlord is normally responsible for continued maintenance and janitorial expenses. The tenant’s rent is still fixed but includes the negotiated operating expenses.
A tenant holding a net lease pays for some, or all, of the landlord’s expenses. The landlord benefits because he doesn’t have to spend time dealing with day-to-day operations. The tenant benefits if the rent is low enough for him to take the risk of a rollercoaster ride of expense predictability. The three main categories of expenses are taxes, maintenance and insurance. Let’s look at the types of net leases.
Single Net Lease
This is the most basic form of net lease. Simply stated, the tenant pays a base rent and his portion of property taxes.
Double Net Lease
The tenant takes on the additional expense of insurance premiums for the building. He pays rent, property tax and building insurance and the landlord pays expenses associated with common areas and maintenance.
Triple Net Lease
The tenant pays for all three of the cost categories. The base rent is typically lower. Though this seems most favorable to the landlord, a tenant can learn a lot by knowing the building expenses firsthand. He can even save some money by having control of the accounts. Landlords who prefer not to have a management role, and strictly own the building for investment, will be proponents of this type of lease.
Restaurants and retail often pay a base rent and percentage of gross income. Rent can also be set as percentage of gross sales alone. Startups and short-term lessees may be inclined to sign this type of lease if they don’t have the base sales currently but expect an increase in business down the road. The percentage doesn’t kick in until a certain amount of gross sales occurs.
A full-service lease is also known as a gross lease. In this case, a tenant’s rent is fixed. All operating expenses of the property are the responsibility of the landlord. The tenant does not have to worry about paying property taxes, utilities, maintenance, and property insurance, which makes it easier to forecast their own business lease obligations.
Leasing vs. Buying Commercial Properties
You’re starting a new business, your organization is growing, or you simply need to find new office space. Do you rent a commercial property or buy a building? There are advantages and disadvantages of both. Do your homework, examine the numbers, and decide what’s best for your business.
Pros and Cons of Leasing
Let’s look at the best-case scenarios for leasing commercial space. If you need to get into a space quickly, or don’t have a lot of working capital, leasing may be the way to go. With many options for renting office space it can be easier to get your foot in the door in a hot real estate market, and with a lower upfront investment than buying. Lease payments are also tax deductible. A landlord may even offer tenant improvements, allowing you to complete an interior to your liking.
If your company is experiencing growth, or downsizing, this may be a good time to lease until your future is somewhat more stable. Leases can also be more flexible, short term or long term, with negotiated expenses, and the choice is up to you to renew the lease (in most cases). Finally, leasing allows you to focus only on your business and not on commercial building issues.
What are some disadvantages of leasing? It can take many walkthroughs of many properties to find what you’re looking for. This is where a commercial real estate broker can help. Your business can also be subject to rent hikes or increases in expenses depending on the lease agreement. The landlord plays an important role and you may be at his mercy regarding timely, and quality, repairs needed in the building. He may also have certain rules and regulations about the building that could inhibit your business.
Pros and Cons of Buying
If you want to run every aspect of your business and have complete control, consider buying your commercial space. Renovations and layout of your floorplan are exactly as you desire.
Building owners have the tax benefits of value appreciation, depreciation and interest. You are building equity and can later profitably sell, refinance or rent the building. There are no guarantees but buying your commercial property can potentially build your own personal wealth.
With complete control comes complete risk. Talk to your financial advisor about interest rates and cash flow and be sure to have the appropriate insurance coverage. You are using a big chunk of your capital as a down payment, take the time to run the numbers. Depending on your neighborhood of choice, you may be faced with a decision to pay more than you were anticipating.
You’ll want to have a thorough building inspection, but even then, issues may surface later that were not discovered in the inspection. Keeping the building in good, working order is all your responsibility, including taxes. Budgeting and forecasting are key to buying and maintaining commercial real estate. Be ready to put down roots for a while, having a mortgage is typically not viable if you only plan to stay in one place for a few years.
Finding a Commercial Real Estate Broker
Legwork is involved in finding a commercial broker that you feel comfortable working with. You will be forming a new business relationship based on commitment and trust.
Where to look
Ask your network for referrals. First-hand feedback about how a broker has performed is valuable. Were they happy with the complete process? Did they feel that they received the right amount of attention? Was the broker honest and would they use this person again?
Ask other commercial tenants. Brokers may specialize in a niche industry, or a specific location. Search out like businesses and ask if they used a broker. Make a list of several names before narrowing it down to a few for interviews.
Online resources exist of course, but hiring a tenant broker will be most beneficial. Relationships with landlords, negotiating expertise, and access to listings helps tenants save time and money.
What to ask
When you’re ready to interview, come armed with questions. You want a broker working full time in commercial real estate, who is an expert in their location. He should have expertise in helping tenants find office, retail and commercial space. Are traffic patterns important to your business? Pay attention to the answers you receive and try to get a sense of any chemistry you have with this person. Find out exactly who you will be working with. If it’s a larger office be certain a newer broker will be in constant contact with a senior broker.
Talk about compensation. In an exclusive arrangement with a broker, a tenant works with one broker for a specified time period. A commission is negotiated, but only paid if there are no tenant broker fees paid by a landlord. Most often, the landlord does pay this fee. This type of agreement shows commitment to the broker however, you should have high confidence that the broker will perform. Maybe he has a few rental properties already in mind or shares a market analysis with you. He has demonstrated his value at this point.
Non-exclusive arrangements allow a tenant to talk to multiple brokers. Even though this may seem like a fine idea, investing time in finding a good tenant broker is better for everyone involved. You’ll have one confidante, one advocate dedicated to matching you with the best landlord. You’re also respecting the broker’s time by allowing him to do his job and be paid appropriately. Commercial listings are accessible by every broker, so thinking that having two, three, or four brokers searching for you is unnecessarily spinning wheels.
What to expect
Both you and your broker want to succeed in business and have a productive relationship. On both sides, good and timely communication is always expected. As a knowledgeable representative, your broker will pinpoint the best commercial real estate for lease based on your criteria and help negotiate the lease.
Negotiating Commercial Lease Terms
You’ve narrowed down your options. The next step is to submit a letter of intent to each of the landlords with the help of your broker. The LOI is a non-binding form of putting terms down on paper and serves as a basis for the longer lease agreement.
Know all you can about each office space including what it currently rents for and what the expenses are. Ideally your broker has asked for the past two years of operating expenses to give you a good history.
● State your intent to lease the space. You won’t be locked into a contract, but this first step shows a landlord you’ve done your research and you’re serious about seeing if it’s a good fit. The best part is that you’re not out any money if you pass on the deal.
● Describe in detail what your company does and how long you’ve been in business. Landlords are just as interested in who you are and what you do, as you are in them. Why would you be a good tenant? If your business appeals to them and is a good addition to their portfolio, it’s a win-win.
● Supply your proposed terms, which are all negotiable. Once you’ve dived into the building’s expenses and current tenants, be as specific as you can about what exactly you’re offering. For example, do tenant improvements include special accommodations for installing large-scale medical equipment and who pays for that?
Let the negotiating begin. It’s always good practice to also have an attorney review the final agreement. Commercial real estate leases can be lengthy and daunting, with language that might be difficult to grasp. Let the experts do their job.
It would be a good idea to have financial documents ready along with at least two references. If you’re working with a broker, he’s the one scrutinizing the lease agreement, looking for ways to save you money, and reviewing any risk exposure.
Even though you’ve got the pros on your side, brush up on the lingo and ask any questions that come up. A good tenant broker has landlord credibility, understands the competitive market, and can navigate any troubled waters that arise.
Common terms in a lease agreement
Premises – This includes details about the space you’re leasing, including the address and condition of the building.
Lease term – This section includes the date the lease is effective and the occupancy date, both usually expressed in months. These dates can be different so that you’re not paying for time in the space if it’s not ready to occupy.
Rent terms – This is where monthly and annual rent is shown. There may also be an escalation clause, allowing the rent to increase at a specific rate in coming years. What is the increase based on?
Security deposit – This amount is fully refundable to the tenant and is provided as a protection to the landlord.
Renewal option – If the landlord is offering the tenant a chance to renew the lease, this would describe any changes in rent or terms of the agreement.
Common areas – if a common area exists, this is where that area is defined, including who is responsible for its maintenance and upkeep.
Use of premises – This describes how you can use the property. Be careful to look for any restrictions the landlord has placed on what type of business can operate in the space. Often zoning dictates this clause and it will also state what activities are prohibited.
Insurance – Typically this will detail the amount of liability insurance the tenant must prove. Negotiations can include rental interruption insurance and leasehold insurance.
Maintenance and repairs – A net lease or full-service lease may determine who pays for the expenses of maintaining the commercial space and who is responsible for repairs. In either case, it is spelled out here.
Improvements, alterations, and additions – The landlord may consent to alterations or initial improvements to the space prior to occupancy. If credits are involved, these can be in the form of tenant reimbursement, reduced rent, or improvements paid for by the landlord.
Subleasing – This allows a business to assign its lease if it wants to eventually sublease the property. This could also come into play if you intend to grow rapidly and wish to sublease the space until you can fully occupy it yourself. Be careful who you end up subleasing to, because you are the one responsible in the end. The landlord could also insist on approval of the new tenant.
Default – If a tenant defaults on the agreement, this section describes what recourse the landlord has.
Termination – This clause talks about how and if the lease can be terminated by the tenant and/or landlord, and what that process looks like. A good item to include here may be the right to terminate if an anchor tenant leaves.
There are several additional clauses that could be a part of your lease agreement including security, parking, signage, access, rent abatement and dispute procedures. Once the lease is in hand, read it thoroughly. Clarify any questions via your attorney or broker and read it again. These professionals are there to help you negotiate the lease with your best interest in mind. You are making a substantial investment in leasing commercial property; it pays to do your homework.
Here are some final thoughts on finding and renting commercial properties.
Keep in mind who your business serves. It doesn’t make sense for an electrician to pay premium rent on a downtown street, but it will make sense for a coffee shop. Will your business thrive by locating in a financial district, close to similar companies? Is vehicle traffic or foot traffic more important?
Industries set different standards for what your rent should be based on percentage of income, ranging from 2% to 20%. It does come down to location for many industries and in the end your goal is to find the best match for your company.
Be sure to check the zoning regulations for any potential restrictions. If you have plans to expand a product line or do any modifications, you want to make sure the property is zoned properly.
Consider multiple properties, up to 7 if possible, to get a true idea of office rents and amenities and the various lease terms landlords are offering in the area. The more you know, the better you’ll be at the negotiating table.
Before signing the lease do a final walkthrough to make sure the landlord has lived up to any commitments he has made. If you’re a veteran tenant, you know that every contract and every office or commercial property is unique. If you’re a first timer, protect yourself by learning all you can about how to lease commercial property and enlist the help of a real estate broker.
Last, but not least, sign on the dotted line and celebrate with your beverage of choice before taking the next step, the move-in.