What to Know Before Signing a Commercial Lease

Moving into a new commercial space is an exciting moment. Whether one is opening a new location or expanding into a larger space, this moment is a mark of achievement. The excitement that comes during this time can often motivate business owners to sign their lease quickly – however, it’s always best to take a step back, do some research, and fully understand the lease before taking this step. Even if it seems like the perfect location, the lease must align with the business owner’s operations to make the lease worthy of execution.

However, unless one is an expert in leasing, how does one know what to look for in a lease? This article outlines some key concepts business owners should know before signing a lease. Taking the time to understand these concepts can ultimately save a business during future economic ups and downs.

The Difference Between a Commercial Lease and a Residential Lease

Many individuals who have signed a residential lease may feel comfortable in their ability to negotiate a commercial lease. While there are some similarities – such as the location, square footage, and rental rate – there are also numerous differences.

For example, since a commercial lease relies on a business, what happens when the business closes or must relocate? Generally speaking, a commercial lease favors the landlord, leaving tenants in a difficult position. Most recently, the COVID-19 pandemic has shown what can happen when tenants are not protected. Throughout the pandemic, business owners across the country were responsible for paying rent even when government shutdowns limited, if not closed, their operations. A commercial lease should outline the what-if conditions in addition to the immediate terms of the lease.

What Makes Up a Commercial Lease

Now, what should a commercial lease include? Here’s a snapshot of the elements a tenant should look for in a commercial lease.

Understand Location, Square Footage, Cost, and Zoning

Every lease outlines the location of the space, including the address and parcel. This section is straightforward. The tenant should be able to pre-vet the location as an optimal site for business. For example, suppose an individual is opening a new restaurant. In that case, they most likely will find a location in a high-traffic area with surrounding retailers. The location in a lease should not differ from the location that a tenant is looking at.

However, one characteristic of the space that could vary is the square footage. Most leases outline both the usable square feet and the rentable square feet. It is essential to understand the difference between the two. “The usable square feet of a space is the total area that’s unique to [a business] and [its] shop or restaurant as the tenant. This includes all interior [area] within the walls of the space defined in [the] commercial lease, including closets and storage areas.” Meanwhile, “rentable square feet includes [the] usable square feet plus a portion of the building’s shared space. Common areas include hallways, lobbies, restrooms, and other shared spaces.” Tenants should understand how much they pay for their usable space versus shared space.

A feature that all tenants should be aware of but most likely won’t see in the lease is the zoning permitted in the space. This information can be found by doing research with the city. The zoning regulation determines the types of businesses permitted to use the space. For example, is the space usable as a warehouse, retail business, or office? Before signing a lease, every tenant should confirm that the business is permitted to operate per the municipality regulation.

Learn Everything About the Landlord

Tenants should research their landlords to ensure they are making a smart move for their business. It’s best practice for tenants to research who they will be doing business with before signing a legal document. This theory also holds for businesses signing commercial leases. Reaching out to a commercial leasing broker during this phase can be helpful. But if the tenant is doing the research independently, here are a few questions to ask to learn about a potential landlord.

• Does the landlord upkeep the building? Neglected maintenance can harm one’s business, so ensuring the landlord takes pride in the real estate is imperative.
• How long has the landlord owned the property, and does the landlord own other properties? An experienced landlord can be beneficial for a new business.
• What’s the reputation of the landlord? Reviews and testimonials speak louder than the landlord’s words.
• Does the landlord permit growth? Suppose a business – such as a startup company – anticipates growth. Does the landlord have additional nearby properties into which the tenant can expand?
• Will the landlord accommodate market changes? How did the landlord respond to tenants facing challenges during past economic downturns? Did the landlord work with the tenant, or did the landlord immediately turn to eviction?
• Reviewing past or current tenants can give a potential tenant insight into the type of landlord and the type of property they are running. What other tenants has the landlord signed leases with? Do they strive for quality tenants who improve the community? Or are they strictly looking for the highest paying tenants?
• Does the landlord use a property manager? If so, that is who you will be doing business with, and you will also want to research the property management company.

Any information about the landlord can help tenants negotiate a lease most suitable to their current and future business operations.

Research Nuisance Laws

Nuisance laws are another condition tenants must consider, especially if they plan to open a restaurant, bar, or similar venue. A nuisance law restricts businesses from being offensive, an annoyance, or troublesome. Most nuisance laws restrict odors, sounds, or specific equipment. So, before signing a lease, a business owner should understand what restrictions are in place to avoid a citation. Suppose the business cannot cook certain food or must keep the noise level to a minimum. Is the selected location the most optimal for the business?  

Understand the Terms of the Lease

While researching zoning restrictions, landlord history, and nuisance laws, it’s also necessary to go back to basics. Every tenant should review the lease terms to confirm they are favorable for their current position and potential growth. The following aspects should be considered:

• How long is the lease? There’s a strategy behind the length of a lease. For example, if a business plans to expand, the tenant should negotiate a short lease. However, if the tenant thinks rates will rise, they should negotiate a long lease.
• How much is the security deposit? Can the tenant afford the deposit, and does it seem reasonable? An unreasonable deposit may indicate an unreasonable landlord.
• Does the tenant have the right of first refusal? In other words, if the landlord decides to sell the building, does the tenant have the first go at purchasing the asset?
• What are the lease payments? How much is the tenant expected to pay each month, and when is the payment due? Also, what utilities or amenities are included? Additionally, are rental increases included? Most commercial leases include rental increases either annually or every few years.
• When does the tenant take possession of the space? Also, is the tenant permitted to make any improvements?

Understand Common Leasing Vocabulary

Every lease is different and can include multiple pages of legal jargon. For tenants first reviewing the lease – beyond the points outlined above – here are a few vocabulary terms to watch out for.

• Late fees: The amount a tenant owes if they are late paying rent – it can be either a percentage of the rent or a flat rate
• Improvements: Outlines the improvements and upgrades that a tenant is permitted to make in the specific space
• Covenants: Indicates what the landlord and tenant are permitted or not permitted to do
• Extension: Determines if and for how many years a tenant can exercise an option to extend the lease
• Obligation for repairs: Outlines who is responsible for specific repairs and the timeline the property owner must abide by to fix those repairs

Review Leasing Statutes

Some key terms in a lease refer to the tenant’s responsibilities in what-if situations. The two most common terms tenants should watch for are transfer structure and personal exposure.

Transfer structure refers to how a lease will be transferred to a new tenant if one decides to vacate the space. Depending on the landlord, the property’s location, and several other factors, this structure can vary. Generally, a lease permits either assignment of the lease or subletting. Assignment of the lease means the tenant can transfer the lease to a new tenant. Subletting means the current tenant can sublease the space; the old tenant’s name will remain on the lease, but the new tenant will pay rent.

Personal exposure refers to the liability the tenant takes on by signing the lease. In some cases, the tenant needs to guarantee the lease personally. In this case, the tenant is responsible for lease payments even if the business defaults. Avoiding this is best since it puts an individual’s personal assets at risk.

Understand How Certain Fees Are Paid

The last – yet most important – aspect of the lease to review is expenses. Who pays for what? Generally, there are five different types of leases on the table. Each differs in terms of what the tenant is responsible for and how much the tenant pays. Expenses include taxes, insurance fees, and maintenance costs for the property.

• A gross lease requires the tenant to pay a flat rental rate, and the landlord pays for all operating expenses.
• A modified gross lease requires the tenant to pay base rent and a share of other expenses.
• A single-net lease requires renters to pay the base rate plus their fair share of property taxes.
• A double-net lease requires tenants to pay the base rate plus property taxes and their fair share of insurance premiums.
• A triple-net lease requires tenants to pay maintenance costs, taxes, and insurance.
• An absolute lease is like a triple-net lease, except it includes greater responsibility for maintenance and repairs down to the structure of the building. The landlord has zero responsibility. 

Some tenants incur additional expenses, such as a cost to have security at the property. These additional expenses vary based on the landlord and the property and can vary in cost. Tenants want to ensure that their rental rate is feasible after considering all costs.

Signing a Commercial Lease

If a business is looking to sign a new commercial lease, there’s a secret that big and small companies use to get the best space at the best price with the best process: they use a leasing broker to help them. Leasing brokers are commercial real estate professionals who focus on assisting tenants find the best location and negotiate the best deal. When a business owner uses a leasing broker, they have an expert in their corner throughout the process, which can help protect their business long-term.