Moving Forward With a Lease
Flexibility is certainly a hallmark of commercial leases, as they allow you to save more money up front and then freely walk away from the property at the end of the lease if you desire. At the same time, however, don’t underestimate the ironclad nature of a lease agreement. It’s legally binding, and, once signed, you will be bound by every word in the document.
“It’s too late to make changes after you’ve signed a commercial lease for an office building or retail space and the ink has dried,” cautions The Balance Small Business. “It’s vitally important that you understand lease terms, how they’ll impact you, and that you’ve negotiated the best deal possible for yourself before you sign a business lease.”
Just as you did earlier in the decision process, you’ll want to consult with your accountant and mentor regarding the commercial lease. Rely on these experts for advice, then scour the documents as though your life depended on it.
Many small business owners also find it helpful to partner with a tenant broker. These experts can help you understand lease nuances such as insurance, property tax, utilities, and more. The money you pay for a tenant broker’s services could easily be returned through potential savings down the road. On top of that, their expertise can help you avoid some of the common property headaches that plague small business owners.
When you find issues in the lease, don’t be afraid to ask questions. Your objective should be to learn as much as you can about the property and agreement. You’ll want to pay close attention to your rights regarding the property. Will you have the flexibility you require? Will you be supported in a way that allows you to carry out your operations in the smoothest way possible?
Once you’ve gathered these details and completed your evaluation of the agreement, you’ll be in a prime position to negotiate the specific points that matter most to your preferences and business goals. You can either conduct the negotiations personally with the landlord or have representatives handle the dialogue for you. What matters most is that your concerns and priorities are vocalized. If you remain silent, you could easily find yourself struggling with regrets.
Understanding the Various Types of Commercial Leases
The variability that exists among the different commercial leases is reminiscent of what you see with business structures for small businesses. If you were to set up your business as an entity, you could choose from options such as a partnership, sole proprietorship, corporation, or limited liability company (LLC). Each of those structures offers unique benefits while presenting you with potential limitations. Anyone making a rash decision regarding their business structure would do so at their own peril.
You encounter a similar scenario with commercial leases. No single type of lease is perfect for all situations. There will be a fair degree of give-and-take with each type of lease. Ideally, you can work out an arrangement with the landlord where the lease aligns with the priorities of both parties.
Here’s an introduction to many of the most popular types of commercial leases available:
Otherwise known as a full-service lease, this common arrangement places most of the burden on the landlord. You’d only need to pay the agreed-upon rent while your landlord would take care of insurance, real estate tax, maintenance fees, operation fees, and other property expenses.
The all-in-one structure of a gross lease can save small business owners a lot of time and effort. Just be aware that while you only pay for rent and not the other expenses, it doesn’t necessarily mean that you are saving money. Pay close attention to the various fees covered by the landlord to ensure they don’t try to sneak in illegitimate expenses or inflate certain fees.
For example, let’s say you sign a gross lease on a restaurant in Omaha, Nebraska. You will pay rent for the duration of your time in the space, but the landlord would cover all other expenses. Even if property taxes go up or the building’s heating system needs to be replaced, your rent won’t change.
Modified Gross Lease
Here’s an option where the responsibility for the property gets distributed a bit more evenly. While the exact breakdown of expenses depends on your unique agreement, you would likely be responsible for rent, utilities, and maybe some of the property’s operating expenses. Additionally, some of these expenses you pay could increase over time.
For example, let’s say you sign a modified gross lease on a retail shop in Reno, Nevada. Your agreement might stipulate that you pay only rent and utilities for the first 24 months. After that point, you would also pay a percentage of the entire building’s operating costs. Because your shop takes up about 20% of the building, that’s the ratio you’d need to cover.
Continuing with this scenario, suppose that the city of Reno decided to raise property taxes a few years after you signed the agreement. With a modified gross lease, you would probably be required to pay a larger amount than before to help cover the increased tax costs.
Net Lease (4 Varieties)
While a modified gross lease is structured so that tenants pay rent, as well as a portion of the building’s overall operating costs, a net lease breaks down the extra financial responsibility into more clear-cut categories. The key operating expenses to consider are usually property taxes, utilities, insurance, and maintenance.
For example, let’s say you sign a net lease on a mechanic shop in Bend, Oregon. You might have 4 different choices available for this net lease:
- Single net lease: This lease is one of the most popular options on the market today. In this scenario, you would pay monthly rent, as well as 1 of the building’s operating costs. For example, you and the landlord might agree that you’ll cover the property tax for your mechanic shop.
- Double net lease: In this scenario, you would pay monthly rent plus 2 of the operating costs. For example, you and the landlord might agree to have you pay the property tax and insurance.
- Triple net lease: In this scenario, you’d pay monthly rent plus 3 of the operating costs. For example, this might include property tax, insurance, and maintenance. You’d also be on the hook for property repairs. So if the floor starts to crack open in your shop, you would need to cover the repair costs.
- Absolute net lease (aka bondable net lease): In this scenario, you would pay monthly rent, plus property tax, utilities, insurance, and maintenance. You’d also assume total responsibility for the property. Suppose that an old water pipe in the back wall burst open and your entire shop flooded. You alone would be responsible for managing the repairs and paying the costs. And during the repairs, you would still need to continue paying rent and the other expenses to the landlord.
Unsurprisingly, landlords love triple net leases and absolute net leases. By transferring most (or all) of the property’s expenses and risks to the tenant, they can continue collecting rent while enjoying protection from the responsibility and expenses associated with property ownership.
It should be pointed out that your rent payments will often be lower with these types of leases, given the higher ancillary costs you’ll be shouldering. If you are ever offered a triple net lease or absolute net lease that doesn’t offer savings on rent, you should speak to the landlord to find out how the arrangement would benefit you. Because if you’re not being rewarded in some way for taking on all the additional risks and costs, you’d be better off with a more tenant-friendly lease agreement.
With this type of commercial lease, you don’t need to pay directly for operating expenses such as property taxes, maintenance, and utilities. But don’t confuse a percentage lease with a gross lease. While a gross lease only requires you to pay monthly rent, with a percentage lease you’d still be asked to pay an extra amount of money each month. The difference is that rather than making you pay for certain expenses such as taxes or insurance, the additional fee would simply be a variable amount based on your sales performance.
For example, let’s say you sign a percentage lease on a seafood restaurant in Casper, Wyoming (even though there’s a stigma against landlocked seafood restaurants, your lobster bisque is absolutely to die for). Your agreement might stipulate that you pay a base rent plus 8% of your sales. During the winter months, when your lobster bisque is selling like wildfire, that extra percentage could be quite high. During summer months, when interest in your bisque wanes, the extra percentage you pay the landlord would decrease correspondingly.
Percentage leases are often used for retailers and restaurants. In fact, if you were to walk through the mall and ask the various store owners what type of lease they have with the property owners, nearly all of them would tell you it’s a percentage lease.
With these leases, you can expect landlords to seek a percentage in the high single digits (7% is common). If a potential landlord is demanding 10% or more of your sales, you should probably look elsewhere. Of course, both parties need to sign off on the percentage before it takes effect.
Choosing the Right Lease for Present and Future
Given the stark differences between each version of commercial leases, your due diligence is a necessity. As you consider various options, keep your priorities front and center. You’ll want to find a commercial lease that aligns with your business goals, rather than trying to retrofit your business to match up with a less favorable lease.
Finally, remember to consider the big picture. If you’re signing a 10-year lease, the property will need to do more than meet your current needs. It must have the space, layout, resources, and location to keep your business thriving for the next decade. By carefully choosing a property and lease that offers this kind of versatility, you’ll set your small business on a successful path well into the future.