How to Evaluate a Commercial Property Lease

A lot of business owners celebrate when they find the perfect location for their new business. But before signing a lease, it’s actually prudent to remember that, no matter how friendly the prospective landlord seems, a lease agreement is rarely in the tenant’s favor. Here are some important points to consider before signing a commercial lease.

Finding a location for a brick-and-mortar store can be a tricky prospect. But once a business owner locates the perfect spot, next comes one of the trickiest legal documents any entrepreneur will ever face: the commercial lease (insert scary music here). And a Google search for “how to calculate lease payment for commercial property” or “how to get a good lease agreement” only yields so much helpful information.

Long story short: most landlords create lease agreements that are most favorable for them, not their tenants. They hope that prospective tenants will sign their agreement without questioning it. They might even pressure the tenant into signing quickly so the space doesn’t get rented by someone else.

No matter how much pressure the landlord gives, smart business owners will take the time to read their lease agreement carefully, understand its terms, and if necessary, negotiate favorable terms (or at least more favorable ones). Reading the fine print can make the difference between a lease that’s a nightmare and one that works for the business.

Here are some things business owners should keep in mind when they’re considering signing a lease for a commercial rental property.

How to Calculate Lease Payments for Commercial Property Rentals

The most basic equation for calculating a lease payment takes the number of square feet times the cost per square foot and then amortizes that expense over a 12-month span. For example, if the space has 1,000 square feet and the cost per square foot is $12, the annual lease amount would be $12,000. Divided by 12 months, the monthly lease payment would be $1,000.

Again, this is a very simplified scenario. These days, most commercial leases include additional factors that affect the final price, such as adding a monthly percentage of the company’s gross sales, property taxes, rent increases, operating expense escalations, common area charges, and more, to the base rent.

Who is responsible for paying what in this commercial lease?

Commercial real estate still has expenses like utilities, common area maintenance, garbage pickup, and more. Prospective tenants would be wise to take some time to understand exactly what their lease covers. Some of the top types of leases include:

Gross lease: In a gross lease, the landlord charges a flat fee for rent. The landlord covers all utility expenses, insurance premiums, and maintenance costs.
Net lease: If a tenant signs a net lease, they’ll be responsible for rent payments and fees for utilities and maintenance. In some cases, these leases can be divided to create a single-net lease, a double-net lease, or a triple-net lease structure (it varies depending on the number of expenses the tenant covers). For example, in a triple-net lease (sometimes called an NNN lease), the tenant pays their rent and taxes, insurance, and maintenance for their total lease cost.
Modified gross lease: This lease type blends the gross lease and the net lease structure, with the landlord and the tenant sharing utilities and other expenses according to the agreement.
Percentage lease: The tenant pays a base fee for monthly rent plus a portion of their business income. This can be common when a landlord is leasing commercial space in retail and industrial properties.

No matter what lease structure the landlord chooses, it’s prudent for a business tenant to ensure they understand exactly what they’re paying for and which expenses the landlord will cover. For example, does the landlord include any tenant improvement allowances in the lease, or will the business have to cover any improvements to make the space suit their needs? Who pays for repairs if the air conditioner goes on the fritz? Savvy business owners take time to understand these terms, and they’ll negotiate the terms when needed.

Can the monthly lease rates for the commercial space go up at any time?

It’s typical for a lease to contain what’s known as an “escalation clause,” which allows the landlord to pass on increased building operating expenses to the tenants. If a lease contains such a clause, a business owner could consider asking for a cap on the amount the lease payment may rise over a given period of time and an accounting of the items that are forcing the increase. This might help avoid a scenario where the property owner ups the base rent fee just because they can.

Will the rent increase every year?

One very important factor to know is if, when, and by how much the business’s rent might go up over the term of the lease. It’s expected that rents will increase as property values rise, so most lease terms include a rent increase on the lease anniversary.

Plus, if market conditions permit the landlord to rent the space for more than the tenant agreed to pay a year ago, they’re within their rights to request the increase. However, it would be a nightmare for the tenant if their rent suddenly doubled. A wise business owner will negotiate the timelines and amounts of increases before they sign the commercial lease agreement. And if the landlord balks at this negotiation, it’s equally prudent for them to find another space, even if the shop’s in a prime location.

Is a personal guarantee required by the lease agreement?

This is an important question to answer: What happens if the business goes south and it can no longer afford to make the lease payment? Is the owner responsible for paying the rent out of their own pocket? Probably so. Most landlords insist on a personal guarantee from the owner or an officer of the corporation. This means that even if the company goes out of business, the owners are still on the hook for the remainder of the money owed.

Finally, be clear on every point in the lease

Rentable square feet can be hard to find, but no one should rush into a commercial rent agreement. It’s prudent to understand every point on the lease.

Look at it this way: a landlord is an investor, and they need to protect their real estate investment. So they draft a contract to protect their interests, and that’s within their rights. But it’s also within the business owner’s rights to protect and negotiate for their own interests, too.

If a business owner finds that they’re unclear on any point in their lease agreement, they can get (and probably should) get clarification from their attorney. How much square footage is included in the lease? What’s the total monthly rent? Who covers operating costs, especially for common areas like bathrooms, break rooms, and so on? Who buys the toilet paper?

That question is only partly in jest; no business owner wants to learn that an amenity isn’t included in their lease terms at the precise moment they need it. With a clear understanding of the terms, business owners can help ensure they know exactly what they’re getting into whether they’re renting office spaces or retail spaces.

Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. For specific questions about any of these topics, seek the counsel of a licensed professional.