7 Terms Every Business Owner Must Understand Before Signing A Commercial Lease
Today, most small businesses start from the owner’s home or apartment. While the home-office may be convenient, owners serious about growing or expanding will eventually need to rent commercial space. Business owners must be careful, however, when considering rental space: commercial leases are not like residential leases.
Although both commercial and residential agreements are legally-binding contracts between a landlord and a tenant, the commercial lease is oftentimes lengthier with added provisions, different fees, unfamiliar phrasing, and tons of real estate jargon.
For this reason, it’s highly recommended to consult a legal professional before signing a commercial lease. This is particularly true for first-time renters, or individuals that are unfamiliar with the language of commercial real estate. After all, once the agreement is signed, it is legally enforceable—whether you fully understood what you agreed-to or not. It’s imperative that potential tenants know and comprehend the terms of their lease before making such a commitment.
Important Terms to Know (and Understand) before Signing
Many first-time commercial renters expect their lease to mirror a typical residential lease. While both agreements accomplish a similar goal, unknowing renters may be taken-by-surprise when they initially review their commercial agreement and encounter a plethora of unfamiliar terms. What is a triple-net? What does it mean by load factor? What are these CAM charges and why am I responsible for them?
Signing a lease without a full understanding of this jargon can be financially disastrous for tenants. This is because these terms and conditions—unlike a residential lease—are oftentimes negotiable. In other words, much of this jargon relates to miscellaneous charges, repayment options, tenant rights, payment structuring, and other expenses. If a tenant signs a lease without negotiating these conditions, they are essentially signing the contract on the landlord’s terms.
Legal counsel can be invaluable in this situation. An experienced attorney will elaborate on the unfamiliar language of the lease, and may actually help with the negotiations. In any case, let’s take a look at a few frequently-used—but commonly misunderstood—real estate terms for the first-time renter:
1. Nets and Net Leases
In the context of commercial real estate, a net is simply another word for a non-rent expense. The three main nets are insurance, taxes, and maintenance. Who pays for these non-rent costs? If the lease is a “Net Lease” (which is usually the case), then the tenant is responsible for one or more of these expenses. Oftentimes, tenants will see the term “triple-net lease”, which simply indicates that the tenant is responsible for payment of all three nets: insurance fees, property taxes, and maintenance costs.
2. Incidental Expenses
Similar to the concept of nets, when the phrase “incidental expenses” appears in the lease, it’s referring to any and all non-rent expenses. These may include taxes, insurance, and rent among other miscellaneous costs. Be wary of this rather ambiguous phrase, as it can render the tenant responsible for all kinds of non-specific costs, like building staffing, property promotional materials, or various administrative costs.
3. Turnkey Build-Out
A turnkey build-out is a negotiated arrangement establishing that the landlord will prepare the space—in accordance to the tenant’s requirements—before the leasing period begins. In other words, the landlord ensures the area is ‘move-in ready’. This is often used as a tenant inducement (the tenant agrees to sign the lease, only if the landlord funds and prepares the fixtures, décor, and other amenities before the move-in date).
4. Tenant Improvements
This is a predetermined sum of money given to the tenant (from the landlord) to improve the rental space. Importantly, a tenant should negotiate for tenant improvements in the lease, so that they have funds available to modify the space once they move in.
5. Common Area Maintenance (CAM) Charges
A frequent point of contention between landlords and tenants, CAM charges are an umbrella term for expenses associated with the maintenance and upkeep of the shared areas of the building. These frequently include utilities, building security, and snow-removal. However, CAM charges can encompass just about any operational cost, so tenants must be careful. It’s important to have these provisions clearly-defined in the lease. Ambiguous CAM charge provisions may render tenants responsible for any and all building operational costs.
6. Load Factor
Rental rates per-tenant are usually proportional to the size of their rental unit (also called ‘usable space’). Sometimes, landlords will include an additional sum on-top of this rental rate, which is calculated by taking a percentage of the total area of the building’s shared spaces. This additional sum is called the load factor.
7. Tenant Inducements
These are basically incentives offered by the landlord to entice (or “induce”) a renter to sign. Just as you need rental space for your business, landlords need to fill their units. Incentives might include a reduction in utility or CAM charges, turnkey build-out arrangements, or rent reduction for the first several months.
Consequences of a Hasty Decision
These seven definitions are by no means comprehensive. Nonetheless, they are frequently found within commercial leases, and tend to be misunderstood by first-time renters. It’s important that potential tenants understand the consequences of these terms before signing their lease. The majority of these concepts represent negotiable arrangements associated with non-rent charges, payment structures, and tenant rights.
Hastily signing a legally-binding commercial lease can result in expensive fees, increased expenses, and less control for tenants. Again, a knowledgeable attorney can be of great assistance here. Before signing, an experienced lawyer should be able to review your lease, clarify any ambiguity, and negotiate for a fair and agreeable contract.