Key Economic Ingredients in a Lease in Commercial Real Estate

To gain a complete understanding of commercial real estate, learning about the basic lease provisions that drive a transaction economics in crucial. The following 7 provisions should be understand to properly grasp the economics of a lease transaction:

Economic Lease in Commercial Real Estate

1. Type of Lease: is the lease a gross, modified gross, triple net, or bond lease? (explain in previous post) An understanding of the lease type will shed light on which party bears the cost burden and/or the responsibility for various operating services.
2. The Parties/Liability: If an entity, as opposed to an individual, care must be taken to understand who the tenant is as well as the tenant´s financial strength. A subsidiary of a large public company signing the lease does not obligate the parent company. You might want to seek the guaranty of the parent. One the lease is signed, the tenant is signed and the tenant is dependent upon the landlord to provide necessary services.

3. The Premises: after the premises are clearly identified, it is necessary to quantify the size of the lease space. Is the tenant renting based upon usable or rentable square meter?
4. Term: the length of time a tenant is willing to commit to leasing a suite is a crucial area. The landlord seeks as long a term as he can obtain; the tenant usually desires to minimize his term and therefore his liability exposure, while possibly cushioning this posture with options to extend the lease.
5. Security Deposit: most landlords think of the security deposit as a fund that is available when a tenant moves out to ensure that he leaves the premises in good condition. It could be used to repair damage to the premises caused by the tenant or to clean the premises upon termination of the lease. If the landlord files bankruptcy, the tenant could find itself as a general unsecured creditor in its attempt to recover its security deposit.
6. Parking: if the lease is silent as to parking, tenants should be aware that the landlord has the right, at a later date during the lease term, to enact a policy to charge for parking.
7. Renewal Options and Termination Rights: usually renewal options and termination rights are drafted to solely benefit the tenant. If the option fixes the rent at a level that is below the current market rent when the option is exercised, then the landlord is often faced with the reality that the option will be exercised. If the option rate is at or above market, the tenant will most likely ignore the option and renegotiate the lease terms.

These lease provisions covering the dollars and cents of the transaction are usually the responsibility of the business individuals involved in the negotiation.

Four Basic Types of Leases in Commercial Real Estate

Four Basic Types of Leases in Commercial Real Estate

Leases are contractual binding agreements between a landlord and a tenant. The lease document controls the rights and liabilities between the parties. You must understand the nature or type of lease you are dealing with. It is important to clearly understand what the monthly/yearly base rent is, how much and when the rental adjustments are, and who bears the various operating cost burden as between the landlord and the tenant. These obligations will directly affect project cash flow and return.

The main differences between lease types concern which party will be responsible for the monetary obligations associated with the operation of subject property and what, if any, obligations the tenant has regarding the mechanical systems, the roof, and the exterior walls of the projects.

Gross Lease:

The operating expenses such as utilities, janitorial, landscaping, trash pick-up, management fees, and so forth are typically contracted and paid for by the landlord. Nevertheless, tenant shall pay its pro rata share of operating costs and taxes over specific calendar year operating costs and taxes. The landlord is responsible to maintain and repair the project systems such as heating, air conditioning, and ventilating, the common areas, the exterior walls, and the roof. A gross lease is usually found in office buildings.

Modified Gross Lease:

Certain operating costs, usually utilities, electric charges and janitorial expenses, are passed on as a direct expense to the tenant. Tenant shall pay as additional rent, without any right of deduction or offset, the actual charge for utility usage for the premises. The utilities shall be placed in tenant´s name and billing shall be made directly to tenant. One expense is a direct charge and the other is over a base year, there could be a charge in on category while there is no charge in the other box.

Triple Net Lease:

It requires the tenant to pay its pro rata share of operating expenses, not over a base year amount nor limited to certain operating costs, but rather to pay 100% of the actual operating costs associated with his percentage of the project. The obligations of maintenance and repair for mechanically feasible passes on to the tenant. However, for the roof and structural integrity of the building remains with the landlord.

This type of lease is commonly found in a retail shopping centre.

Bond Lease:

The tenant is not only responsible for the maintenance of the interior leased area, but usually is also responsible to maintain and replace, if necessary, the building systems, as well as to repair any damage that occurs to the exterior, including the roof and the structural components of the project. The destruction and condemnation risk is passed on to the tenant. Hence, if the building is destroyed by an earthquake, even if the tenant did not carry earthquake insurance, the tenant must continue to pay rent and must rebuild the structure!