May 7

What are the typical lease terms and agreements in commercial real estate transactions?

Commercial real estate leases are complex agreements that form the foundation of many business operations. Whether you’re a new entrepreneur looking for a first location, or a seasoned investor expanding your portfolio, understanding the typical terms and conditions of these leases is crucial. Here’s a breakdown of common elements you’ll encounter in commercial real estate lease agreements.

1. Lease Types

There are several types of commercial leases, and the choice can significantly affect your costs and responsibilities:

Net Lease: Tenants pay base rent plus a portion of the property’s operating expenses, like taxes, insurance, and maintenance.
Double Net Lease (NN): Includes base rent, property taxes, and insurance costs, but not maintenance.
Triple Net Lease (NNN): Tenants are responsible for base rent, property taxes, insurance, and maintenance. This is common in single-tenant buildings.
Gross Lease: The tenant pays a flat rental amount, and the landlord covers all property expenses.
Modified Gross Lease: A mix between gross and net leases where the rent is fixed, but some expenses may be shared.

2. Term Length

The lease term refers to the duration of the lease agreement. Commercial leases typically last between 3 to 10 years, which is longer than residential leases, providing stability for both tenant and landlord. Longer leases may include options to renew, allowing the tenant to continue occupying the property under predefined conditions.

3. Rent and Escalations

Rent is often quoted as a price per square foot per year. For example, "$20 per square foot per year" means a 1,000-square-foot space would cost $20,000 annually. Many commercial leases include an escalation clause that allows the landlord to increase the rent annually by a fixed percentage or based on the Consumer Price Index (CPI) to keep up with inflation.

4. Build-Out Provisions

In many commercial leases, especially in retail and office spaces, tenants might need to modify the space to suit their business needs. Lease terms should specify who handles these modifications (tenant improvements or TIs) and who pays for them. Some landlords offer a “tenant improvement allowance,” which is a set amount towards the cost of renovations.

5. Maintenance and Repairs

Responsibility for maintenance and repairs can vary greatly depending on the lease type. In triple-net leases, the tenant may be responsible for most maintenance and repairs. It’s important for tenants to understand what elements they are responsible for to avoid unexpected expenses.

6. Sublease and Assignment Clauses

These clauses dictate whether and how a tenant can rent out the property to another party. Subleasing can be critical for tenants who need flexibility to downsize, relocate, or cease operations. Restrictions on subleasing can severely limit these options, so it’s a key term to negotiate if flexibility is important.

7. Termination Clauses

Termination clauses outline the conditions under which the lease can be prematurely terminated. This includes detailing what breaches would allow a landlord to evict a tenant, or under what circumstances a tenant can legally break the lease without severe penalties.

8. Option to Renew

An option to renew allows the tenant to extend the lease under specific conditions, providing more stability for business planning. The terms for renewal should be clearly outlined, including how rent adjustments will be handled during the renewal period.

Understanding the typical lease terms and agreements in commercial real estate is essential for navigating this complex area effectively. Both landlords and tenants should work with real estate professionals to tailor lease terms to their specific needs and ensure that all parties have clear expectations. This careful preparation will pave the way for a successful and profitable relationship in the commercial real estate market.