Commercial Lease Terms Every Property Manager Should Know

Whether you’re a first-time investor negotiating a lease agreement or a veteran brushing up on your glossary of property management terms – understanding the various commercial lease definitions is critical. Here’s a breakdown of the most commonly used commercial lease terms and agreements.

The Difference Between Gross Leases and Net Leases

There is no one-size-fits-all approach to commercial leasing. Lease agreements between landlords and tenants can take many different forms. To start, let’s define the difference between a gross lease and a net lease.

Gross Lease

A gross lease is a lease in which the landlord pays all (or most) expenses associated with owning and operating the property. This ‘all-inclusive’ lease agreement is sometimes perceived as the most tenant-friendly lease type as the tenant can budget for a regular flat fee. However, the gross lease may be higher than necessary to protect the landlord from cost increases over time.

Net Lease

A commercial net lease is a lease agreement in which the tenant pays base rent plus additional expenses such as insurance premiums, maintenance costs and property taxes.

From a landlord’s perspective, the advantage of a net lease is that it offsets the variable costs of property ownership to the tenant. For example, if property taxes increase by 2% next year, it is the tenant’s responsibility to cover the additional rate in a net lease arrangement.

However, net leases can be risky for the landlord. Imagine a tenant fails to keep their property tax payments up to date; this may result in additional fees and fines that the landlord is responsible for paying. Even public utilities are often charged against the property title if the tenant defaults on the payments, resulting in an additional surprise for an unaware landlord.

The Differences Between Single, Double and Triple Net Leases

Where net leases can differ is dependent on how the operating costs and expenses are allocated. Here’s a breakdown of the three basic types of net leases and what they mean for landlords and tenants.

Single Net Lease

Single net lease properties are the least common of the bunch. In these leases, the tenant is responsible for paying base rent, plus all or a portion of the property taxes. Whereas all other expenses such as operating costs, maintenance costs and insurance costs are managed by the landlord.

Double Net Lease

A double net lease, also known as a semi-gross lease, is an agreement in which the tenant pays the property taxes and insurance premiums in addition to the base rent. All other expenses, such as maintenance and repairs, are paid directly by the property owner. 

Triple Net Lease

Much different than the ‘all-inclusive’ gross lease agreement, under a triple net lease the landlord is ‘hands-off’ as the tenant is responsible for all property taxes, insurance, maintenance and repairs in addition to the base rent.

Historically, triple net refers to leases where one tenant rents an entire commercial building and pays all property expenses for a longer-term (ten years or more). As leasing practices have evolved, the term triple net lease now also describes leases for a multi-tenant building where each tenant pays its proportionate share of expenses.

The Pros and Cons of Single and Multi-Tenant Net Leases

Whether an investor is looking to establish a single-tenant net lease property or a multi-tenant net lease property, both types of options have their advantages and disadvantages.

Single-Tenant Net Lease

A single-tenant net lease is a rental agreement between the one sole occupant of a space and its owner or landlord. Due to their simplicity, single-tenant net leases are often a good fit for first-time investors.

Of course, investing in a single-tenant property heavily relies on the quality of one sole tenant. A sudden vacancy could result in financial implications for the landlord.

Multi-Tenant Net Lease

Comparatively, in a multi-tenant net lease the odds of total vacancy are very low. A multi-tenant net lease is a lease between a landlord and a tenant where there are also other lease agreements within the same building complex, typically in a larger commercial retail property.

However, it may increase duties as multi-tenant buildings usually require more structural maintenance and repairs, and additional provisions to consider.

Retail Lease Agreement: Common Clauses

Retail lease agreements have various provisions to ensure both landlords and tenants are protected. The following terms are just the tip of the iceberg when analyzing the multiple permutations that can inform a retail lease agreement. 

Retail Anchor Tenants

For many retail tenants, success is dependent on their neighbours. Anchor tenants is a term that refers to the key retailers that play a critical role in bringing crowds and human traffic to malls. Landlords are very likely to provide favourable rental rates and terms to anchor tenants, as they help sustain the business of smaller retailers.

In some leases, an anchor tenant agrees to a “continuous occupancy clause,” which is a provision in a lease that requires the tenant to stay open during specified hours and operational throughout the period of tenancy.

Strength in Numbers

Another negotiable lease agreement provision for retail tenants is the "go dark" clause. Under the go dark clause, tenants can stop operations in an unprofitable space while still paying rent for it. A tenant may choose to go dark for a few hours, days or weeks. They may wish to focus their resource on more profitable locations, or they may need time to overhaul the space decor.

Consequently, if anchor tenants or multiple anchor tenants leave the retail space, it is likely to result in a drawback of foot traffic and less business for the remaining tenants. Thus, the need for a co-tenancy clause. A co-tenancy clause is a retail lease provision which provides the tenant with protection in the form of reduced rent to compensate for traffic loss.

A provision that is advantageous for both property owners and tenants is known as “percentage rent.”

Simply put, percentage rent is additional rent paid by the tenant based on a percentage of gross sales. The idea behind percentage rent is to give the owner the opportunity to negotiate the placement of a retailer in exchange for a percentage of their sales. If a tenant is experiencing periods of slower sales, the rent adjusts lower to accommodate the lower cash flow the tenant is experiencing.

Calculate the Fees

Now that we have a baseline understanding of the various lease agreements and clauses, we’ll conclude by exploring different lease expenses and how they are calculated. 

Percentage Rent

With a percentage rent lease, a tenant must first pay a minimum rent. Once gross sales surpass a specified mark known as a ‘breakpoint’ the tenant is required to pay the owner a certain percentage of every additional dollar in sales as additional rent.

Natural vs. Artificial Breakpoint

The breakpoint is an important negotiated method, as there can either be a natural or artificial breakpoint.

A natural breakpoint is calculated by dividing the base rent by an agreed percentage.

Whereas, an artificial breakpoint may be determined by the bargaining power of the parties or specifics of the transaction. For example, a landlord may negotiate a breakpoint below the natural breakpoint, while a tenant with more clout may be able to negotiate a higher breakpoint.

Operating Costs

Operating costs are common expenses that are paid frequently as they are necessary to operate and maintain a property. Operating expenses are often tacked onto a lease agreement in various forms such as property taxes, property insurance, maintenance expenses and utilities.

Capital Costs

Unlike operating costs that are frequent and relatively low-cost, capital costs in a commercial lease are intermittent, expensive upgrades to the property that provide long term value. These expenses are paid by the landlord and then amortized over a period of years. 

Common Area Maintenance

Common Area Maintenance charges, also known as CAM expenses, are the fees paid for the upkeep of areas designated for use and benefit of all tenants in a shared space. CAM expenses are common in multi-tenant lease agreements such as shopping centers and can include charges for maintenance, snow removal, utilities and more. (https://cressblue.com/calculating-the-cams-common-area-maintenance/)

There are two basic calculations for CAM fees: variable CAM fees, where the amount charged to the tenant can vary based on expenses that may fluctuate monthly, and flat CAM fees, where the fees are a fixed amount.

CAM cap refers to the maximum amount for which the tenant pays its share of common area maintenance costs, and the owner pays for any CAM expenses that exceed that amount. 

Can you optimize your commercial leasing systems?

What other leasing terms are important in your PM business? What part of lease administration do you wish was more efficient or more clearly defined?

#leaseadministration #leaseterms #leasedefinitions

This article is for informational purposes only and is not intended as professional advice; please consult a competent professional for advice specific to you. This blog is written to stimulate thinking on concepts related to commercial leasing. Please join the discussion with your experiences.