Leasing commercial property can be difficult if you don’t know what you’re doing. But considering how vital finding the right commercial property is for your business, it is definitely something worth looking into more deeply. Even a fantastic building with a poorly negotiated lease could spell trouble for you, so knowing how to negotiate a commercial lease is just as important as picking your ideal location.
So what kinds of questions should you be asking the landlord? And when leasing commercial property, where is there room in the contract to reduce your monthly payments? And what really makes the perfect location for your business? All of this and more is answered in this complete guide to leasing commercial property for your business.
How does leasing a commercial property work?
Leasing a commercial property is similar to signing a rental agreement for a residential property, except that in commercial leases the contracts tend to be for longer time periods (three to five years) and there also tends to be a lot more room for negotiation.
In addition, there are a lot more expenses and contractual considerations when it comes to commercial property. That means that when leasing commercial property, you really need to know exactly what you’re looking for and exactly what your lease says you are obligated for. But knowing these things means you will get the best deal possible.
Things To Think About When Looking For Your Ideal Commercial Location
There are a lot of ways to look for property. Of course your broker can help to show you locations, but you should be looking too. Googling “leasing commercial property near me” can turn up good results. Loopnet and crexi.com are both very popular websites for commercial property listings as well. Even driving around an area you like can be a profitable use of time.
Ultimately when it comes to commercial property leasing, the more buildings you look at, the better. Doing so means you will slowly become an expert as to what is available in your local market. Here are a few things you should think about when searching:
Every property has specific zoning which determines what you can use the space for. For example, if you want to open a restaurant, the property would need to be zoned for this type of business. Zoning laws can be found by contacting your local chamber of commerce, or by googling your zip code or city plus “zoning regulations”.
Another point to consider is that even if the property is zoned for a specific use, the space still needs to meet codes and regulations for the jurisdiction. Often the landlord will pass this responsibility on to the tenant, so it’s important to look into this.
Your Square Footage Requirements
You should have a fairly accurate estimate of how many square feet you need for your business. For example, if you have a company with 20 employees and are looking for office space, you could calculate how much space you will need to accommodate 20 people. Of course you should also consider plans for expansion, and depending on how much you plan to grow in the near future, should target locations which will accommodate your growth.
A good rule of thumb for offices is 100 square feet per person.
For restaurants use these estimates:
- Fine dining: 18–20 square feet per customer
- Full service restaurant: 12–15 square feet per customer
- Fast casual or fast food: 11–14 square feet per customer
The main point here is that you should be thinking in terms of square footage and how much space you will actually need to conduct business. For a retail location, the amount of inventory you will be holding would need to be calculated to get an idea of how many square feet you will need.
Your Monthly Rental Budget
You should have an idea of the maximum amount you would be willing to pay for your ideal space. Knowing this will help you in the negotiation stages since you will have a target of what you need to get your rent down to in order to guarantee a profitable endeavor. How to calculate your monthly rent is covered more in depth later in this article, as well as what expenses you will need to think about.
The amount of buildout you will need to do is going to depend heavily on the type of business you are going to operate and how the space was set up for the previous tenant. Look for buildings where the previous tenant was doing the same type of business as you, since this can greatly reduce buildout costs. As an example, a second generation restaurant can drastically cut down costs and get you open for business faster. Getting an estimate of buildout expenses is something you should do for each new space you view, as this can vary widely from location to location.
Another thing to know is that sometimes landlords will offer tenant improvement allotments. These can be arranged in a number of ways, but essentially it means the landlord will pay for improvements to the building up to a certain amount. Ideally the landlord would pay the contractors directly or offer you a free rent period, because if the landlord transfer you the money to pay for the improvements, it can be taxed as income.
Data On The Type of People in The Area
This type of information should be available from the landlord. You will want to look at the average income in the area and see how it compares to the products or services you will be offering. Education levels and average home prices would also factor in. The main idea to think about is whether or not you are located near your ideal customer.
For office space, you’ll want to consider the average distance this office will be from your employees. But it’s also important to think about future hires, and whether or not your ideal employee lives in this area. Additionally for offices, think about access to highways, as commute time can be a factor in attracting employees.
The Three Main Types of Commercial Leases
It’s important to know the difference between the three main types of commercial leases which are net leases, full service leases (also called gross leases), and modified gross leases. Every lease is different and specific to the building you are leasing, but these terms are broadly used to describe the most general arrangements that can occur.
A net lease means the tenant pays a base rent plus additional fees for items such as property insurance or property taxes. There are three types of net leases:
- Single net lease: The tenant pays a base rent plus a portion of the building’s property taxes.
- Double net lease: The tenant pays a base rent plus a portion of the buildings property taxes and a portion of the buildings insurance.
- Triple net lease: The tenant pays a base rent plus a portion of the buildings property taxes, a portion of the buildings insurance and a portion of the buildings common area maintenance fees (CAMS). This is the most common type of commercial lease.
Full Service Leases (Gross Lease)
In a full service lease the tenant pays a base rent which covers all costs. This means the landlord is responsible for paying all other costs including property insurance, property taxes and common area maintenance fees (CAMS). This is the easiest type of lease to budget for since the amount will not change month over month.
A full service lease will always have the highest base rent of all the lease types (all other factors remaining constant) as all fees are included within a full service lease. However it is important to actually read the lease when agreeing to a “full service lease” as there could be expenses the tenant is responsible for that are not considered “full service” by the landlord.
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Modified Gross Leases
A modified gross lease is when the tenant pays all fees (the base rent, property taxes, property insurance etc.) as one lump sum. Essentially all of these fees are calculated together as one price per square foot. This type of lease is common in office buildings where the tenant would pay a prorated amount of the shared building expenses.
How Is Base Rent Calculated In a Commercial Lease?
Your base rent is calculated by the usable square footage of your space. This is a simple calculation of price per square foot times the usable square footage, which equals the yearly amount of rent due. Here’s an example:
Usable square footage: 2,000 square feet
Price per square foot: $57 (This was the average price per square foot for the D.C. area in 2020)
Yearly rent calculation: 2,000 x $57 = $114,000
Monthly rent calculation: $114,000 ÷ 12 = $9,500
Percentage of Profit Rent Agreement
Some rent is paid based on a percentage of the total profit of the business. This would make sense for a landlord who has a high traffic location and wants to capitalize on the potential profit of his tenant. This can be done in two different ways, illustrated by these examples:
Base rent + a percentage of the total profit over a certain amount.
Base rent: $100,000 per year
Percentage of profit over $250,000 which goes to rent: 10%
Yearly profits: $400,000
In this case the business made $150,000 more than the minimum ($250,000), so only pays the 10% on the $150,000.
Total rent due calculation: $100,000 + ( $150,000 x .10) = $115,000
Base rent + a percentage of the total profit.
Base rent: $100,000 per year
Percentage of profit to rent: 10%
Yearly profits: $400,000
Is this case the business would pay the the 10% on their total profit of $400,000
Total rent due: $100,000 + ( $400,000 x .10) = $140,000
Typically a business would agree to a percentage of profit lease when the overall base rent was reduced. Sometimes the landlord will assist the tenant in growing their business in these types of leases as it would be in the landlord’s best interest to do so.
The Major Expenses of Leasing Commercial Property
The four main expenses when leasing a commercial property are going to be your base rent, property taxes, building insurance and common area maintenance fees (CAMS). Depending on your lease type these might be separate fees and fluctuate month to month, or be included all together as one lump sum.
These are taxes owed on the property by the landlord. Depending on the type of lease you have, these will either be covered by your base rent, or you will pay them yourself directly. The landlord should be able to provide data on how much property taxes are on the building.
The building must have insurance, and this is the responsibility of the landlord. This insurance would cover flood damage, fire, onsite injury etc. Depending on your lease agreement, insurance will either be paid by the landlord (and covered by your base rent), or you will pay it separately each month.
Common Area Maintenance Fees (CAMS)
This would include all types of fees associated with the building including any repairs, management fees, parking lot repairs, roofing, structural repair, heating, electricity etc. These are highly negotiable and are important points to consider in your lease.
In larger buildings these are split up among the tenants. And in some buildings these fall 100% on the tenant. The landlord may also choose to keep control of all repairs and simply charge a high rent and pay these fees out of pocket at his discretion.
What Questions To Ask When Leasing Commercial Property
Even if you are working with a tenant broker, it is important to understand what kind of questions you should be asking your prospective landlord. The following will give you an idea of the subjects you’ll want to be thinking about.
What amenities are included? This would include common areas that you would have access to in the building or on the property.
What parking is included? While you can simply take a quick look over the parking lot, some leases don’t include use of all the parking adjacent to the building.
Why did the last tenant leave? This can give insight into any potential problems the location has. For example, maybe the last tenant was a retail shop that didn’t get enough foot traffic and had to move out.
What changes can be made? This is extremely important if you know you are going to be doing a lot of buildout prior to moving in. Every landlord will have different rules about what you can and can’t do to the building.
Is there an arbitration clause? Having an arbitration clause means avoiding an expensive lawsuit in case of a dispute. A neutral arbiter can be designated who can speedily resolve any disputes in the lease.
What capital expenditures are you required to pay for? You need to find out about important expenses that could arise such as HVAC, roofing, the parking lot etc. The lease will detail what items the tenant is expected to pay for in the event of damage or breakage.
What is the electrical capacity of the space? This will be important for certain businesses with specific electrical requirements such as a company housing large servers. But it’s important to ask about the electricity to determine the cost, and to make sure the building is wired for what you will be doing.
Does the building come with any furniture? Some office spaces for example will have furniture in the building. This might be furniture from the previous tenant, or furniture owned by the landlord. When viewing a property make sure you know what is staying and what is going if there is still a tenant occupying the space.
How many cars drive by per day? The landlord should have this data, but if they don’t you can try asking the local government. If neither knows, then you can do a rough calculation by counting how many cars go by in 5-10 minutes and doing the math yourself. It’s also important to pay attention to how easy or difficult it is to turn into the parking lot of the building.
What signage is allowed? If you want to display a sign above the building or on the road, make sure what you are planning to do will be approved in your lease.
Who is the landlord? Since you are going to be entering into a contractual agreement with this person, you should get as much information about him or her as possible. Going into business with someone who could default on their payments for example could be very risky. If the landlord is responsible for paying the property taxes on the building and does not pay, even if you were in full compliance with your lease and making your payments, you could still be evicted. Research your landlord and any other business he is involved in.
Are there any use restrictions? Some leases have specific clauses that limit the use of the space. Look out for these as not knowing about them could potentially stop you from operating your business.
Are there any non-compete clauses within the building? Some buildings have clauses which state that no other business of the same type can open in that building. Always ask because you wouldn’t want to waste time by finding this out too late into the leasing process.
What is the annual base rent increase? Most leases state what percent the rent will increase per year, if any. This is important to know in terms of calculating your long term budget.
Working With a Broker To Lease Commercial Property
When leasing commercial property there are two types of brokers–listing agents and tenant brokers. The listing agent is the broker for the landlord and works on his behalf. It is optional for a tenant to use a tenant broker, but it is highly recommended.The only downside to using one is that by using one you pay the tenant broker fee (typically a percentage based fee).
A tenant broker can help by:
- Providing you with a list of available real estate which suit your criteria
- Giving you accurate market pricing and data
- Sharing knowledge about local market conditions
- Assisting you in negotiating your lease
- Offering access to financing options
- Connecting you with local professionals for legal advice and licensing criteria
- Introducing you to contractors for space buildout
How To Find a Good Tenant Broker
Ideally you would meet a tenant broker through your professional network, but websites such as the brokers list would be a good place to look otherwise. Here are a few things to consider when working with a broker:
- Is the tenant broker knowledgeable of the area?
- What is the size of the broker’s real estate practice?
- How is the broker being compensated?
- Would you be required to have an exclusive arrangement with the broker? (In some cases a tenant broker will want you to sign such an agreement to prevent you from working with other brokers.)
- Does the broker have experience in leasing the type of buildings you are looking at?
Overall it is important to establish that your broker has enough knowledge of the market to show you properties that are going to suit your needs, and that he can effectively negotiate on your behalf.
How to Negotiate a Commercial Lease
The great thing about commercial leases is that there tends to be a lot of opportunity for negotiations. That means if you know what to ask for, you can gain significant advantages and reduce your expenses. Whether you do this yourself off with your broker, knowing what to ask for is key.
Overall, the most important thing to do is actually read and understand your lease (or have your broker explain it to you). There are a lot of clauses in a typical commercial lease–which may seem inconsequential the day you sign the lease–but could mean significant losses for your business at some future date. Here are some things you should consider doing:
Verify the square footage yourself. Sometimes the square footage claimed by the landlord is not accurate. This can occur when multiple tenants have used the space over the years and made various changes to the space, thus altering the actual usable square footage. Since your rent is calculated per square foot of usable space, this is extremely important.
Ask for a free rent period. In some cases when negotiating the price of your rent, a landlord might be hesitant to lower the rent since it could influence future rents or even the overall value of the building. But knowing this, you can ask for a rent free period. This effectively gives you a discount on your rent without negatively affecting the value of the property for the owner.
Ask about the cure period. The cure period is the amount of time that late fees are not applied. This is important, as with some leases, if you are even one day late due to something silly like an accounting error, you could be charged excessive late fees.
Ask about a co-tenancy clause. A co-tenancy clause is typically important when your space is significantly tied to another major tenant. For example, if you have a lease within a large building where a Wal-Mart was the major occupant, you could include a co-tenancy clause which states that if Wal-Mart leaves for any reason, your lease is no longer binding.
Add a no-compete clause. This is common in buildings such as strip malls where you want to have an exclusive business type in that area. For example if you had a Mexican restaurant, you could negotiate a clause in your lease that the landlord cannot lease any of the other spaces to another Mexican restaurant.
Put HVAC responsibilities on the landlord. This can often be overlooked by tenants as it can appear to be a minor detail. However if your lease states that you are responsible for any heating or air conditioning replacement costs, this could turn into a major expense.
Make sure you have a long enough fixturization period. A fixturization period is the time you have to install equipment, move in furniture, and make any necessary improvements to the space before your lease begins. A fixturization period that is too short could put undue pressure on you to open.
Clearly define the force majeure clause. A force majeure clause relieves the tenant of his lease, or gives major concessions to his lease in the event of “acts of god” such as hurricanes, floods etc. This affected a massive amount of businesses in 2020 when tenants around the country discovered that their force majeure clause did not cover being made to close their business because of a pandemic. Ideally this part of your lease will be as clearly stated as possible as to what actually would be included, so as to avoid any dispute in the event of a disaster.
Remember that at the end of the day it is your responsibility to know exactly what your lease says. Once you find the perfect location which fits your needs, it’s time to negotiate the best deal possible. The more you know about the local market, and the general structure of commercial leases, the better you will be able to negotiate. By viewing a large amount of properties you will also increase your power of negotiation since you will know what the competition is offering.