Closeup of Lease Agreement with calculator

A Commercial-Free Examination of the World of Commercial Leases

10+ min read • Nov 03, 2020 • Grant Olsen

While some small business owners are able to operate out of their homes, many are required by the size or structure of their operations to get a commercial space. This can be accomplished by either buying or leasing the property. With a purchase, you would either pay for the property up front or finance it with a loan. Leases, on the other hand, are less permanent. You rent the space for a certain period of time, often in the range of 3–10 years.

If your business needs a commercial space, you will likely have many options to choose from. Whether you live on the East Coast, West Coast, or somewhere in between, there are many factors to consider.

“Have you ever walked through a major city and counted all the different commercial property types?” asks Forbes. “There are gas stations, hotels, strip malls, apartment buildings, industrial buildings, municipal buildings, office buildings, funeral homes, churches, synagogues, cemeteries, and more. Yes, cemeteries! Did you know that grave plots are sold by the inch? They are commercial real estate too. Commercial investment properties range in size from a small, single-story, 750-square-foot office building to the Sears Tower in Chicago that is 4.5 million square feet. There is no other investment that I know of that gives you 4 types of income over time: rental income, rental increases, appreciation, and saving on your taxes with depreciation.”

This wide range of possibilities means you’ll need to do your due diligence before signing any type of agreement. The experts from SCORE recommend that you ask the following questions to ascertain whether a property is a good match for your business:

  • How large or small an area do you need?
  • Do you need walk-in traffic or simply industrial space?
  • Do you want an anchor store nearby?
  • What amenities do you desire?
    • Air conditioning/heating
    • Elevators
    • Windowed offices
    • Conference room
    • Private restrooms
    • Kitchen
    • Wi-Fi

Based on your responses to this quick checklist, you can begin the process of narrowing down your options. You’ll also want to decide if you’re going to purchase or lease the property.

There are some clear benefits to buying a property, though the need for a down payment makes it more of a financial burden for most business owners. Luckily, small business loan options can help you secure the money you need without risking a cash crunch.

“Commercial real estate isn’t cheap,” advise the real estate experts from Small Biz Rising. “If you’re a small business owner who’s considering buying or further developing commercial real estate—whether that’s an office building, a shopping center, a hotel, or another business-related property—odds are you’ll need to secure financing from an outside lender. In most scenarios, that usually means applying for a commercial mortgage loan.”

If you can get approved for a loan, the process of buying a commercial space suddenly becomes much more attainable. The benefits of purchasing include:

  • Gaining a valuable asset
  • Developing equity in the property
  • Freedom to alter the property any way you desire
  • Ability to rent out a portion of the property for extra cash
  • Potential tax breaks

On the flip side, there are disadvantages to buying a property. These downsides include bigger expenses from the get-go, the need to acquire liability insurance, and the risk of the property’s value declining.

Now let’s look at the pros and cons of leasing a property for your small business. Here are some of the advantages you’d likely enjoy with this option:

  • Option to vacate the property once the lease ends
  • More money available up front
  • Tax deductions
  • Fixed property costs for the duration of lease
  • Ability to get into a space you couldn’t otherwise afford
  • Possibility of maintenance being provided by the owner

Of course, it’s not all glitter and rainbows with a commercial lease. Some of the disadvantages are unsurprisingly the inverse of the benefits of purchasing. For example:

  • No equity to build
  • No benefit from the property as an asset
  • Lack of control over the space

You’ll need to consider all these variables before deciding whether to buy or lease your space. This is a great time to seek insights from your accountant, as they can inform you of potential tax strategies related to either approach. The resulting financial outlook could reveal a clear winner and expedite the decision for you.

It’s also recommended that you consult with your business mentor. Talking to a seasoned entrepreneur who has both owned and leased can illuminate some of the nuances you wouldn’t otherwise encounter until after making your decision.

Moving Forward With a Lease

Clients sign Commercial 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

Clients shown lease types

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:

Gross Lease

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:

  1. 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.
  2. 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.
  3. 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.
  4. 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.

Percentage Lease

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

Couple happy about new commercial lease signing

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.

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Grant Olsen

Grant Olsen is a writer specializing in small business loans, leadership skills, and growth strategies. He is a contributing writer for KSL 5 TV, where his articles have generated more than 6 million page views, and has been featured on FitSmallBusiness.com and ModernHealthcare.com. Grant is also the author of the book "Rhino Trouble." He has a B.A. in English from Brigham Young University.