Commercial Lease Agreement Templates
A commercial lease agreement is a contract used by property owners and landlords to rent out all, or a portion of a commercial building to a tenant that will use it for business purposes. Commercial property includes apartment buildings, offices, retail spaces, restaurants, industrial warehouses, hotels, and land.
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A commercial lease agreement is a document used to bind a landlord (lessor) and a business-owning tenant (lessee) into a three (3) to five (5) year contract in which the business-tenant will make routine monthly payments in exchange for use of the property. In comparison to the more widely-used residential leases, commercial leases are typically unprotected in the eyes of state laws, requiring parties to lean on negotiation and knowledge to ensure they are financially and legally protected during the course of the contract.
Generally speaking, there are three (3) major types of commercial leases that a landlord and tenant can enter into. The lease “types” refer to how the cost of rent is determined. The types are “Gross,” “Net (includes three sub-types)” or “Modified Gross.”
- Tenant pays a flat-fee every month (or rental term).
- Least favorable option for the landlord in most scenarios.
The gross lease puts a considerable amount of liability on the landlord. If anything were to happen to the rental, the landlord would be required to front the bill. Additionally, if the tenant(s) decided to excessively use electricity, water, heat, or another utility, the landlord would financially suffer. There are ways landlords can work a gross lease to their benefit, however. One example is if the landlord has plans to install waste-saving plumbing and toilets, or they plan on generating their own electricity via solar, wind, or another alternative energy. By locking the tenant into a rent that includes the cost of the current utilities at the beginning of the lease, and then making the energy-efficient additions to the property, the landlord can end up saving money that they would have previously not seen (because the tenant would be paying for utilities).
- Three (3) types of net lease: Triple Net (NNN), Double Net (NN), and Single Net (N).
- Require the tenant to pay additional costs/fees in addition to the base rent.
- ALL three types almost always require the tenant to pay for both utilities and janitorial expenses.
To understand the three (3) types of net leases, one needs to understand what each net entails. The three nets are:
- Property Taxes
- Property Insurance
- CAM charges (“Common Area Maintenance”)
Triple net leases, the most popular type of net lease, includes all three (3) of the above operating costs, requiring the tenant to pay for the property taxes, insurance, and any common area maintenance (CAM) charges (driveway maintenance, administrative fees, common area lighting, window washing, etc.). A sub-type of the triple net lease is the “absolute triple net lease,” which puts the tenant in a situation where they carry all risk for the property. If the rental was partially destroyed in a tornado, for example, the tenant would be liable for all costs associated with the repair.
Double net leases require the tenant to pay for two (2) of the nets, which are 1) property taxes, and 2) insurance.
Single net leases have the tenant pay just one (1) of the nets (in addition to utilities and janitorial expenses): the rental’s property taxes.
NOTE: Net leases commonly have the tenant pay a “pro-rata” share of the expenses they’ve agreed to pay. “Pro-rata” translates to “in equal portions,” meaning the tenant will only pay expenses equal to the amount of space they are renting in the property. For example, if a tenant is renting a 3,000 sq. ft office out of a 10,000 sq. ft building, they will only be charged thirty percent (30%) of the building’s property taxes, insurance, etc.
- The “best of both worlds” of the gross and net leases; serves as a form of compromise.
- Rent amount does not change in event utility costs go up or down.
A modified gross lease is formed by taking parts from both the gross and net lease. During negotiation, a rental amount will be set for the entire duration of the lease. This is unlike a net lease, which can fluctuate depending on the use of utilities and other operating expenses. In summary, modified leases can be edited heavily to appease both parties in the agreement; certain utility costs can be taken by the tenant (that otherwise wouldn’t) and vice-versa.
The major steps in calculating commercial rent are:
- Calculate Rentable Square Feet
- Determine the Base Rental Rate
- Identify the Additional Rental Rate for Expenses
- Calculate the Monthly / Yearly Rent
The following are terms that are essential in finding the rentable square footage of a commercial property:
— Important Terms —
There are three important metrics to understand in terms of identifying the total number of square feet a commercial tenant would be charged for. They are:
- Gross Square Footage – The entire area of a commercial property. Includes all usable space, common areas, hallways, and more.
- Usable Square Footage – The space that the tenant(s) use to work in. Does not include common areas.
- Rentable Square Footage – Includes the usable square footage, plus a portion of the total common areas in the property.
- Load Factor – The value used for identifying the additional square footage to account for common areas. The additional square footage is then added to the usable square footage to determine the total rentable square footage (the final value).
— Measure the Property —
Using a ruler, the landlord should measure every room and space in the entire property, taking account of which areas are common areas and usable space.
— Calculate the Load Factor —
The load factor is the value used to determine what percentage of common areas the tenant should be responsible for. Once all measurements have been made, it is a straight-forward value to calculate:
Gross Square Footage ÷ Usable Square Footage = Load Factor
In other words, it is the property’s entire area (including interior + exterior walls, HVAC systems, and more), divided by the area that is rentable by tenants (not including common areas). The “Gross Square Footage” can also be seen as the usable square footage plus all common areas.
Once the landlord knows the Load Factor, they can use it to calculate the total rentable square feet the tenant would be responsible for paying for. To calculate, all the landlord has to do is multiply the square feet of the rental by the load factor, as shown:
Usable Square Footage (of the rental/space) X Load Factor = Rentable Square Footage
The following is an example using the two equations:
A 50,000 sq.ft office building with 40,000 usable square feet. To identify the load factor, the calculation would look like the following:
50,000 sq.ft ÷ 40,000 sq.ft = 1.25 load factor (or 25%)
If a tenant is looking to lease a 10,000 sq.ft office space within the building, the total rentable square feet they would be paying for would be:
10,000 sq.ft * 1.25 = 12,500 rentable square feet
Note: 25% is an exceptionally high load factor; the average is between ten and twenty percent (10-20%).
Unlike the rentable square feet, which is generally unchanging (although methods in measuring can produce different results), the base rental rate fluctuates based upon a number of variables, which are:
- Property expenses
- Location of the property
- Value of the property
- Square footage
The most important metric in ensuring a commercial property remains profitable is its Net Operating Income, or “NOI”. This is a valuation metric used for separating income and expenses, ensuring the landlord understands the lowest base rent they can charge without incurring a loss.
The general formula for Net Operating Income is: Gross Operating Income – Operating Expenses. The costs involved in the NOI are directly related to the third (3rd) step.
The additional rate for operating expenses depends on the type of lease that is used for renting out the property. The major types of commercial leases are Gross, Net, and Modified leases. Additionally, commercial property may take a percentage of sales for restaurants, retail stores, and similar businesses (in addition to the base rent). Percentage leasing helps tenants that otherwise wouldn’t be able to afford the rent at the beginning of the rental term, while simultaneously providing the owner with greater income later on (so long the company stays in business).
— More on Percentage Leasing —
In a percentage lease, landlords only collect a percentage of sales after the tenant achieves a certain dollar ($) amount of sales. The amount is known as the breakpoint. There are two (2) types of breakpoint: natural and artificial. An artificial breakpoint is any number that the parties agree on, and does not necessarily involve computation. On the other hand, the natural breakpoint is based upon the monthly rent paid to the landlord and the percentage taken. To determine it, the landlord will take the monthly base rent for the property and divide it by the percentage being collected. The most common percentage taken is seven percent (7%), although the value can vary depending on a number of factors.
As an example, a base rent of $10,000 with a percentage of 7% would be: [10,000 ÷ .07] ~ $142,857. The landlord would thus receive seven percent of any revenue above $142,857, in addition to receiving the base rent and any other expenses.
— Determining Expenses —
As mentioned previously, expenses in commercial renting are made up of three (3) major parts (also known as the three “nets”):
- CAMs – Common Area Maintenance charges)
- Real Estate Taxes
- Property Insurance
As an example, a triple net (NNN) lease would have the tenant pay for the yearly taxes, insurance, and common area and maintenance charges in addition to the base rent. Similar to the load factor, landlords only charge tenants for the cost of utilities proportional to the area they rented.
To calculate the total rent the business tenant will be responsible for paying, the landlord will need to add the base rental rate to the operating expenses rate.
For example, if a 12,500 square foot space has a base rent of $15.00/sq.ft and an expenses rate of $3.00, the rate would look like:
$15/SF + $3 NNN = $18 Total Rate (Yearly)
Then, to calculate the yearly rent, the total rate would be multiplied by the rentable square feet (found in step 1), which would be:
12,500 SF * $18 = $225,000 / year
To determine the monthly rent, divide the yearly rate by twelve (12), which would be:
$225,000 ÷ 12 = $18,750 / month
“…commercial leases are more complex than a purchase or sale agreement because a lease sets up a relationship—not a single event.” – Six Secrets To Commercial Lease Negotiation
Out of all the lease types available to landlords, the commercial lease, by far, is the most complex and requires the most negotiation. Historically, negotiation lies in favor of the landlord/property owner, as they are the ones that draft the initial contract. However, landlords should be prepared to face a significant amount of questions and objections if the tenant they are forming an agreement with is business savvy in the slightest. Why? Because a business’ success can be influenced heavily by the terms contained in the contract (rent amount, permissions granted to the tenant, who pays for what utilities, etc.) For landlords, the following should be kept in mind during the negotiation process:
1. Fight for a Longer Lease
As any seasoned entrepreneur will know – things can change in a moment’s notice. While the average business owner expects their business to thrive (why else would they be signing a lease?), they know that by signing a longer lease, they can be in a world of financial hurt if their business fails with time left on the lease. That’s why short-term leases are typically preferred by renters. Landlords, on the other hand, should fight for a lease with a longer-term. This allows them to focus on other matters instead of needing to look for a new tenant. If the landlord finds a tenant that will not budge on wanting a shorter lease, it is almost always worth offering a decrease in the rent (within reason), taking on an additional utility, or permitting the tenant to sublease, in order to lock-in the longer term.
2. Understand that Lowering the Rent may be Beneficial
Faced with 1) locking in a tenant at a longer term, 2) agreeing to a triple net lease, or 3) or agreeing to other beneficial conditions (such as restricting subleasing), the landlord can lower the cost of rent. However, it’s important to note that this should not be done in situations where the housing market is strong and/or the rental has a lot of attention from prospective tenants.
3. Use a Lawyer
For property owners not accustomed to the leasing process, involving a lawyer can be extremely beneficial. The cost of hiring a lawyer can be minimal in comparison to the risk landlords face in signing a contract that doesn’t meet their best interests. It can be easy as dropping off a copy of the lease to the attorney with notes and highlights asking their advice on proceeding. Additionally, having a lawyer rebuttal (or give advice on) a tenant’s request(s) can be equally invaluable. The attorney will know what conditions and terms the landlord can’t budge on as well as learn what can be altered in order to acquire the terms that would benefit the landlord the most. In short, if the property owner is in doubt about their ability to negotiate, hire a lawyer.
Step 1 – Download
Step 2 – Date & Party Identification
Enter the day, month, and year that the lease is entering into effect, followed by the full name of the landlord and tenant(s).
Step 3 – The Property
- The full address of the property
- A detailed legal description of the commercial property
Step 4 – Lease Term
- Starting date of the lease (day, month, and year)
- Ending lease date (day, month, and year)
Step 5 – Rent Payments
Enter the full yearly amount that the tenant will be required to pay, followed by the amount in monthly increments (divide it by 12). Below the values, enter the address or location where the payments are to be delivered.
Step 6 – Expenses
Check the box corresponding to the type of expenses that will be paid for by the landlord or tenant (Triple Net, Modified Gross, or Gross)
Step 7 – Damage
In the highlighted field, enter the number of days the tenant has to notify the landlord (lessor) of lease termination in the event the property is damaged by structural defects, casualty, or fire, thereby rendering the property unusable for the tenant’s purpose.
Step 8 – Default
Enter the number of days that can pass after the landlord has issued a notice before the landlord can officially terminate the lease.
Step 9 – Security Deposit
Write the dollar amount of security deposit that is due to the landlord the tenant before or during the signing of the lease.
Step 10 – Notice
In the provided spaces, enter both the landlord and tenant’s addresses in which all notices should be mailed or delivered to.
Step 11 – Brokers
- If the tenant was not shown the commercial property by a real estate broker or agent, check the first (1st) box.
- If the tenant was shown the property by a licensed realtor, check the second (2nd) box, write the name of the agent, the state of the agent’s license, and the name of the real estate agency.
Step 12 – Governing Law
Enter the name of the state in which the property is located, the laws of which will have influence over the contents of the lease contract.
Step 13 – Required Disclosures
If the lease does not already contain the state’s specific required disclosures, enter them into the lines provided.
Note: It is highly recommended that an attorney specializing in commercial leases or a licensed realtor overview the lease to ensure it contains all the necessary provisions before signatures are recorded on the contract.
Step 14 – Date of Signing
Input the date the parties are signing the commercial lease.
Step 15 – Signatures
In the fields provided, enter:
- Witness Signature and Printed Name
- Landlord Signature and Printed Name
- Tenant Signature(s) and Printed Name(s)
The following guides and handbooks can help new and experienced landlords learn the ins and outs of leasing commercial property: