6 Crucial Clauses & Terms in Commercial Leases
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This article was updated on 10/24/23.
Commercial leases require careful study. Although they may seem to be just like their residential counterparts, the truth is that they can differ tremendously.
If you're considering searching for retail space for lease, you must look at all of the different terms you'll find in a commercial lease agreement: The success of your future business depends on knowing exactly the agreement you're getting involved with.
With that in mind, let's look at some crucial clauses & terms you must know when leasing commercial space.
How Commercial Leases Differ from Residential Leases
As mentioned, commercial leases tend to vary dramatically from their residential counterparts. Here's what you need to know:
- Way more negotiation: Commercial leases are designed in a way that invites negotiation from both parties.
- Incredible flexibility: You can set up a commercial lease in a way that helps you protect your upcoming business launch.
- Built for the long term: The commercial lease is far longer in term than the residential one.
- More responsibilities: Since it's a commercial lease, there is a higher degree of responsibility compared to the residential lease.
Despite the benefits, the freedom and flexibility of a commercial lease aren't without concerns.
#1 – The Lease Term & Subleasing Potential
One area of interest is the lease term, as well as the potential to sublease the property. Subleasing generally isn't something that landlords tolerate in the residential space, but that isn't the case with commercial property. Not only can you sublease to another entity, but you can also set it up where the subleasing arrangement takes care of most, if not all, of your lease obligation.
This is the case when looking at retail space for lease and finding that you may not need as much space as you initially planned. Instead of scrapping the location completely, you can get a subleasing opportunity with additional benefits.
Remember that the other company subleasing from you is trying to run a business, which means they're engaged in marketing activities. They can lease part of the space from you and advertise to other people you wouldn't have thought to advertise to, basically doubling your efforts without increasing your marketing costs.
Take your time regarding the commercial lease term. Even though the terms are longer than residential leases, they're still negotiable. In other words, you can agree to a longer term in exchange for some concessions or a shorter term if you're willing to pay a little more. Every lease is going to require negotiation before the final agreement.
#2 – Rent Abatements & Escalations
Commercial real estate comes with rent abatements , which are periods where the rent does not need to be paid or can be delayed. This is very different from residential leases, where the landlord expects to be paid all the time.
Rent abatements are very conditional and are spelled out in the lease. A common issue that would trigger rent abatement is when the property is in need of serious repair and cannot be used for commercial activities.
Rent escalations are the complete opposite, as they are specified periods where the rent can go up. They are clearly laid out in the commercial lease, so tenants cannot say that they were not informed ahead of time.
#3 – Net Lease vs. Gross Lease
The biggest difference between a net lease and a gross lease is what's actually paid. Indeed, a gross lease covers all additional expenses in one payment, so the tenant doesn't have to worry about property taxes or insurance. However, if the lease makes those expenses something the tenant has to handle on their own, that would be a net lease.
#4 – Space Dimensions & How the Landlord Measures Them
Calculating space for a commercial lease is very different. It depends on the building. For example, a regular warehouse is pretty straightforward in terms of square footage.
However, an office building with multiple tenants gets trickier. We have to account for what is usable as well as what is not usable. Elevators would not be counted as usable space, for example.
The landlord will handle the calculations and present you with the total square footage and the price per square foot.
#5 – Any "Build-Outs" or Planned Expansions
In order to make a commercial lease advantageous for you, it's important to know who is responsible for improvements around the property. In addition, it's important to also know who gets to own the enhancements made to the property.
What if you put in better handicap access, for example? Do you own the additional fixtures, or does the owner automatically get ownership of this improvement?
Building out retail space for lease is often necessary in order to ensure the space grows as your business grows. However, you still want to be careful with adding to a property that you don't own, as it is the owner who ultimately gets to build equity in the property.
#6 – Mediated or Arbitrated Disputes?
All things come to an end, and commercial leases are definitely an example of a contract that terminates. Some leases are only for a set time, and the landlord can decide not to renew the lease. It is much harder to get out of a commercial lease than a residential one, and there are often high penalties for breaking a commercial lease.
Make sure that you understand how disputes are handled. Will both of you have to go before a mediator, a neutral party that helps settle disputes, or an arbitrator? Arbitration is considered much more serious compared to mediation, as both parties agree that the decision the arbitrator makes is final.
The arbitrator is presented with evidence from both parties, and then they use that information to make their final decision. Mediation is less formal and encourages both parties to come to an agreement. Both strategies are used to try to avoid litigation, which is much more expensive.
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