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Commercial Resources

Lease Definitions

What's Included in a Commercial Lease Document?
As you enter into a new commercial lease, there a certain terms you may need to understand. Here are the common sections of commercial leases, and a brief explanation of these sections. There is no standard for lease documents, each one may be different, with varying order of the items explained below.

Party & Property (Recitals)

Parties
The official names of the tenant and landlord.

Lessor or Landlord
The lessor is the person who is granting the lease and who has the legal obligations related to the lease contract; the landlord. Sometimes this is an owner, but it may also be a property management company or commercial leasing company.

Lessee or Tenant
The lessee is the person leasing the space; the tenant.

Premises
Describes the space you are renting. Verify that you understand how the space is assigned and what specifically you are paying rent on.

Options
Describes the options you may have to rent additional space in the building if it becomes available, or options to buy the property.

Tenant Improvements
This is an allowance provided by Landlord to be used by Tenant to construct the space to meet Tenant's space requirements.

Turn-key
An office or building that is ready to occupy. In most cases, this is a commitment by the Landlord to bear the cost of any build-out.

Rent Abatement
Decrease in rent due to interrupted or inhibited actions of the landlord.

Money Provisions

Term
Explains when the lease begins and ends. It may have initial term and renewal term if applicable. This section may also describe how the lease may be re-negotiated.

Rent
Explains how the rent is calculated, including common area maintenance (CAM) and other costs associated with the lease. It may also contain any escalations in rent

Gross Square Foot
The total square footage of the building or office being leased.

Usable Area
It is the tenant’s rentable area les certain common areas shared by all tenants of the office building (such as corridors, storage facilities and bathrooms).

Rentable Area
The actual square foot area for which the tenant will pay rent, it is the gross area of a building, less uninterrupted vertical space (such as stairways and elevators). Unlike useable area, rentable area includes common areas such as lobbies, restrooms and hallways, as well as the measurement of structural columns and architectural projections.

Base Year
The Landlord agrees to pay an expense amount based on a base year(typically the first year) and the Tenant pays the increase in expense for subsequent years.

Load Factor
Load Factor is a method of calculating total monthly rent costs to a tenant that combines usable square feet and a percentage of square feet of common areas. Usable square feet + percentage of common area square feet = rentable square feet.

Utilities
If utility costs are included in the lease, it explains how they are distributed among the tenants. In some cases, each tenant may pay separately for each utility. If the tenant is paying the utilities, this section may explain the requirement to pay them and what happens if they are not paid on a timely basis. This protects the landlord if the tenant fails to pay.

HVAC
An abbreviation for 'heating, ventilating, and air conditioning.’ May be listed under Utilities.

Parking
Describes the parking available for the leased space. Some lease documents differentiate between where employees may park and general customer parking.

Taxes and insurance
Discusses who pays property taxes and insurance on the property. This section usually includes a requirement that the Tenant provide proof of insurance on property and equipment in the leased space and liability insurance, to protect the Landlord.

Deposit
Describes the security deposit the Tenant is required to provide, and the circumstances under which it may be forfeited or returned.

Common Area Maintenance (CAM)
This term describes costs for areas in a building which are not directly leased but which are a common responsibility, such as hallways, restrooms, stairways, and walkways. Most Landlords add CAM costs to square footage costs to calculate lease payments

Use and Restrictions

Use/Restrictions
Lists the restrictions on the use of the premises, including: signs, hours of use, and limits on occupancy and sub-lessees.

Maintenance
Describes who is responsible for making and paying for maintenance and repairs. Most leases require Tenants to pay for repairs due to "wear and tear" (common usage), with the Landlord being responsible for extraordinary repairs due to major damage or failure of equipment.

Right of First Refusal
This is an agreement by Landlord to provide Tenant the first right to lease space that becomes available in their building.

Allocations and Risk

Indemnify of Lessor
The Lessor is protected against the Lessee from any claims, actions, damages, liability and expense in connection with loss of life, personal injury, and/or damage to property arising at the Leased Premises.

Relations with 3rd Parties

Destruction/Condemnation
These clauses describe what happens if the leased space is destroyed or condemned.

Subordination, Non-Distrubance, and Attornment
Describes rights of the Tenant if the Landlord's lender forecloses on the property. This section protects the Tenant against being ejected by a new Landlord or the bank.

Assignment/Subletting
Some leases have a separate section describing the conditions under which you can sub-let (divide) the space.

Estoppel
Explains what happens if there is a change in the Landlord's situation, to verify that the Tenant is living up to his/her duties as a Tenant.

The Remedies

Defaults and Remedies
Describes what happens if one party defaults (breaks the agreement), and the remedies available to the other party.

Hold Over
Explains what happens if the Tenant does not leave at the end of the lease.

Attorney Fees
Agreement about who pays attorney fees in the event of a lawsuit between Landlord and Tenant.

Dispute Resolution
Some leases provide for alternate forms of dispute resolution, like mediation and arbitration. Have an attorney review the terms of the lease, to explain any specific terms that you don't understand, and to look for issues that might be a problem for you or are not what you thought you agreed to.

Types of Leases

Fully Serviced Lease
A lease in which the rental payment includes other services, such as utilities, maintenance, and lawn/snow removal services.

Gross Lease
A lease in which the Landlord agrees to pay for all common expenses (CAM), including utilities, repairs, insurance and (occasionally) property taxes. The cost of a gross lease is higher than for other types of leases because all of these items are included in the amount of the lease.

Net Lease
A lease which the Tenant pays the square footage costs, CAM costs, and all other ownership expenses, including utilities, repairs, insurance and property taxes.

Double Net Lease
A lease in which taxes and insurance expenses are included in the lease payment. The Landlord pays maintenance costs.

Triple Net Lease
A lease which includes all taxes, insurance, and maintenance costs are in the monthly payment.

Lease vs. Buy vs. Sale Leaseback

Lease

Benefits

  • No worry of selling if you are moving to a new location
  • Monthly rent is a tax deduction as a business expense(subject to the term and accounting guidelines)
  • Flexibility to sublet or move if needed at the expiration of the lease
  • No loss if owning in a bad market
  • Less cash investment up front
  • More cash for expansion
  • Know what expenses will be as stated in the lease

Disadvantages

  • Rental rates with annual escalations based on market conditions
  • Loss of the reversion or the value of any remaining capital investment at lease end
  • No equity buildup or appreciation value of property
  • May be forced to move at the end of the lease
  • Contractual Penalties
  • Subject to Landlord / Property Manager’s operational control
Buy

Benefits

  • Interest on the mortgage loan is tax deductible
  • You know what the fixed operating cost are going to be based on your specific site needs
  • Changes can be made to the building to accommodate your specific business
  • You can take annual depreciation deductions on taxes
  • No annual rent increases
  • You can benefit if you sell when it is a strong market and your property has appreciated
  • Earn income by leasing excess space
  • No restrictions on hours of business operation
  • The location of your business remains constant
  • You can take a line of credit on your loan to make improvements

Disadvantages

  • Usually requires more initial capital to secure financing
  • Property values may decline
  • Subjects the owner to various legal, safety and regulatory risks not associated with leasing (must purchase insurance)
  • Requires owners to invest time, energy and funding in managing the property, which is typically not a core aspect of your operation, unless a Property Manager is hired
  • Inexperienced owners may operate their real estate inefficiently and increase operating costs
  • Increase in property taxes, management costs and upkeep
  • Adjustable Loans
Sale Leaseback

Benefits

  • Continued use of the familiar property during the lease term
  • Removes a capital asset from the balance sheet at book value and replaces it with cash realized from the sale
  • Free up cash for other investments
  • Help reduce business income tax liability caused by the appreciation in value (land only) of its corporate real estate assets
  • Monthly rent is a tax deduction as a business expense (Subject to the term and accounting guidelines)
  • Flexibility to sublet or move if needed at the expiration of the lease
  • Can usually structure the initial lease term
  • Provides new owner with long-term tenant, making it an appealing property to be purchased

Disadvantages

  • If the rental market softens, may be locked into the higher rental rate negotiated at the time of the sale-leaseback
  • Loss of the reversion or the value of any remaining capital investment at lease end
  • Loss of future appreciation of property value
  • May be forced to move at the end of the lease if no renewal options are built in
  • Contractual Penalties
  • Now subject to Landlord / Property Manager’s operational control
  • Lose the flexibility associated with property ownership, such as changing or discontinuing the use of the property or modifying a building
  • Tax impact may be substantial if the property has been owned for a lengthy period and/or the book value is low compared to the selling value
  • Loss of potential sub-let income

Tennant Retention Tips for Landlords

Obtaining new tenants can be a costly affair for landlords. If tenants are dissatisfied, given today's market, they can easily seek new space. It is always the preferred option to retain good tenants – those who pay their rent on time and cause little or no problems.

Why are long-term leases good for landlords?

  • They reduce the potential of "void" periods between tenants
  • Extended vacancy or frequent tenant turnovers are expensive and can create unfavorable market perceptions
  • Long-term leases reduce the risk of getting an undesirable, marginal credit tenant – if you've got a good one, keep it!
  • You already have an established relationship with your current tenant and both of you understand the expectations you have of each other
  • There will be less credit and reference checks to perform
  • The fewer times furniture / fixtures are moved in and out of a property, the less likely there is to be wear and tear or minor damage to door frames, carpeting / floors and paintwork =less replacement costs
  • Reduces the landlords cost of capital required for new tenants
  • Asset pricing is a function of the quality, quantity and durability of cash flows. Longer leases = more stability (assuming a creditworthy tenant) = less risk = higher price

The Coldwell Banker Commercial® organization offers these tips to assist in retaining tenants:

  1. Meet your tenant
    Even though the property was bought as an investment, you are still in the people business and going out of your way to meet up with lessees can lead to longer, more meaningful dealings between yourself and your tenant. Also, understand their business and business model. They may have unique requirements.
  2. Don’t get complacent
    A long-term tenant is a valuable asset in a saturated rental market, so make sure you keep on top of all those little jobs that will make it easier for the tenant to feel like it is a good working environment.
    • Maintain the property in the best possible condition; make sure equipment is up to date
    • When the tenant reports maintenance problems, sort them out immediately
    • Issues involving water, electricity, heating and air conditioning or safety should be resolved inside of 4 hours with a follow up to the tenants.
  3. Have the right atitude
    Show that you're fair-minded and understanding. Don't act like the tenant is „bothering' you when they call. Be pleasant and show concern for their needs. Don't ignore their questions or distresses.
  4. Replace a minor item at least once every year
    Have a plan to maintain the property on an annual and rotating basis so you are constantly generating a fresh appearance. Keeping up with some of the competing buildings will make a tenant see you care about the property and they will be less inclined to look around for unnecessary reasons. Amortized over time, the be attractive to new tenants, and they increase the value of the space.
  5. Tenant improvements
    Requests for improvements should always be considered. Be open-minded and flexible with the tenant's space. The tenant can always restore the space to its prior condition if agreed.
  6. Respect their space
    When landlords meet tenants in their property, be respectful, friendly and informal. Avoid disparaging comments causing them to be unsettled by voicing possible future plans that are adverse to the current tenancy.
  7. Pro-active problem search
    Perform regularly scheduled “preventative maintenance checks.” Make sure the tenants are aware of when such things are scheduled. Performing these checks demonstrates a proactive approach as opposed to a “wait and see” and allows you to find issues before they escalate to a stage where they hand in their notice. Always ask if everything is acceptable or if the tenant has any problems.
  8. Communication is key
    Make sure you communicate with your tenants on a regular and consistent basis throughout their tenancy. Let them know if there is a scheduled maintenance such as parking lot cleaning so they can make arrangements. Tenants don't mind being inconvenienced once in awhile as long as they are aware and can make the necessary arrangements.
  9. Ask what would make the building better
    Another great way to increase your relationship is to speak to your tenant and inquire as to what would make their environment better to work in. Tenants might have ideas, but don't openly present them. Many times, it may be something really small that could make the world of difference. If it is a bigger item, it may be possible to amortize the cost in the general operating expenses if all the tenants will benefit from the suggestions.
  10. Send your tenants anniversary and holiday cards
    This is a simple thing that can go a long way. Write your tenants a hand-written note inside. Another idea is to give your tenant a small gift, like a DVD player, when they first move in. It is small, but they will realize you are not an ordinary landlord.
  11. Improve property energy efficiency
    In today's market, efficiency and sustainability are very current issues that more and more tenants are acutely aware of. If your property is inefficient, cold or drafty, a tenant won't want to extend their tenancy. That inefficiency can translate in higher operating costs. There are many federal programs and tax advantages to retrofits of properties that result in efficiencies and reduced operating costs. These will go a long way to helping retain tenants.
  12. Improve property grounds
    Maintaining the front door to your property and the common areas where people walk thru on a constant basis is an often overlooked and important tool to help retain tenants. Plant flowers in the front of your property. Keep the parking lot clean, the grass mowed and the bushes trimmed. Make the property inviting to come into work.
  13. Offer a re-signing bonus for a lease extension
    The simplest and easiest way to incentivize your tenants to stay is to offer them a discount for signing a new long-term lease. Consider how much money and time it would cost you to find new tenants. Look to incentivize your tenants for signing up early, possibly with free rent, a larger tenant improvement allowance, reduction of security deposits, an offer to refresh paint or carpet during their lease term, etc. (Note: be proactive with such a program and start two years in advance of the expiration of their lease, to encourage them not to look at other options).
  14. Rent reductions
    If a tenant gives notice because they can't afford to continue renting the property, consider revising and extending their term to help get the rent down or draw a new lease up for a longer period of time. Repositioning the lease is better than having them move, potentially losing rent revenue or the required new and likely larger capital dollars to make the space ready for a new tenant.
  15. Why are they looking to leave?
    Always cross-examine the tenant on why they want to leave when they give notice. It's vital to find out their objections to try and overcome them. Sometimes it's an issue you can't do anything about, such as lack of space, but other times it's something simple that's easily resolved and encourages them to stay.