Every day thousands of people start new businesses, often using their savings to build their dream and achieve financial success. Many people will start a business from their home, and as they grow, they realize they need more space to handle the business and space that is zoned for commercial business. Buying a building is very expensive, especially for a small company just starting out; however, leasing a commercial space provides many more options, especially from a capital and cash flow perspective.
Businesses that are just starting out as well as those that have been established for some time enter into a commercial lease arrangement to preserve capital. They can use this capital for other operational purposes instead of investing the funds into real estate. We will explore more about what a commercial lease is and how they are used.
What is a Commercial Lease?
When a business rents space from a building owner, they agree to all of the terms concerning timeframe, what kind of business will operate on the premises, modifications allowed, and many more details. These contracts are often referred to as commercial lease agreements. Few businesses own the building they operate out of. Instead, they lease the space from the building owner. Shopping centers, restaurants, office buildings, and even small mom & pop shops usually do not own the property. They all rent the space from the owner, who typically invests in real estate holdings like shopping centers, large office buildings, and small strip malls.
What Is a Commercial Lease Agreement?
The commercial lease agreement summarizes all of the terms, conditions, and responsibilities of both the landlord and the company leasing the commercial space. Everyone from mom and pop shops to large corporations uses commercial lease agreements to document the arrangement between them and the landlord. The agreement will also cover how the agreement can be broken should the company need to move out of the premises.
In addition to an exit clause, items such as utilities, how the property will be used, modifications to the property, insurance coverage, payment terms, and the term of the lease are covered along with many more special clauses that are often unique to the landlord and the company renting the property.
These agreements are legal documents that are approved and signed by both parties with all of the corresponding obligations.
Commercial Lease Agreement Templates & Examples
Commercial Lease VS. Residential Lease
Conceptually, commercial and residential leases are much the same. In both cases, a lease document is signed and agreed to by both parties agreeing to rent a property to a tenant. Both include a term and a rental amount on a monthly basis.
A residential lease describes the agreement to rent a home (House, Townhouse, or Apartment) to a renter for them to live in. The lease may or may not include utilities, a place to park a vehicle, and access to facilities in an apartment building.
A commercial lease describes an agreement between a landlord and a company to rent space in a commercial building for use by the business. It may or may not include utilities, taxes, parking for customers, modifications, and other issues specific to the commercial property and the business that will operate out of this space. The objective is to ensure there are no loose ends that could put either party at risk.
However, they are very different in other ways as well, and we will list some of those differences:
- Industrial space – includes warehousing or factory space
- Office space – used for employees to operate the business
- Retail space – used in shopping centers, restaurants, small stores
- Parking space – may or may not be included
- Triplet costs – may or may not include insurance, taxes, and maintenance
- Specified clauses – adherence to disability access requirements and hazard waste disposal
- Include options – to renew, to purchase, and first right of refusal
How to Use a Commercial Lease Agreement?
The objective is to manage the risk for both parties. Different properties and businesses will have different terms and conditions. All terms and conditions must be addressed and negotiated to the satisfaction of both parties. The generic terms that are included in every agreement are as follows:
- The beginning and end date of the lease
- Can the lease be renewed or terminated early, and under what conditions?
- Who pays the utilities, maintenance, and property taxes?
- Can improvements be made, to what extent, and who shares in the cost?
- Must cover how the property will be utilized.
- Are hazardous materials, chemicals, combustibles, or machinery allowed on the property?
- Rent increase provisions for long term leases
- Property description, including appliances and existing finishes
- Shared or exclusive use of the property
- Are subleases allowed
- Is parking available, cost, and how is it assigned
- Adherence to local and state laws
While this is not an inclusive list of everything needed in a lease agreement, it covers most of the major items. Every business is unique and may require special provisions to be added to the commercial lease agreement.
How to Write a Commercial Lease Agreement (Step-by-Step)
Writing a generic commercial lease agreement is straightforward, provided a lease agreement template is utilized. It will need to be customized to fit your situation, the type of property, and special conditions that need to be added to reflect your property. The following is a step-by-step approach to writing a commercial lease agreement.
- Date of Agreement – date the agreement is agreed to by both parties
- Lessor’s Name – the name of the landlord or entity with the legal right to rent the property
- Lessors Address – mailing address of the lessor
- Lessee’s Name – entity or individual renting the property from the landlord, use the full name of the person or the entity
- Lessee’s Address – formal mailing address of the lessee
- Street Address – the physical address that includes building number, street number, unit number, city, state, and zip code
- Square Feet – useable square feet inside the building. Include the ceiling height if appropriate
- Type of Space – define the type of space that is being leased and how it is intended to be used – industrial, commercial, retail, manufacturing, warehousing, etc.
- Other – add details if needed to further describe the space
Use of Premises
- All-Purpose – if the space can be used for any purpose and not restrict the lessee in any way, choose this category.
- Specified purpose – if the space is to be limited to a particular business type or industry, select this category and specify the business activity that can be carried out on the premise
- Lease Term
- Period of lease – include the years and months the lease is effective from the date specified on this lease.
- Term Start Date – provide the calendar date that the lease begins
- Term Expiration Date – provide the final date when the lease will end
- Waiving of the Security Deposit – if a security deposit is not required by the lessor, it should be noted on the agreement.
- Requested Deposit – in many cases, a security deposit is required and can be 2 to 3 months’ equivalent rent. The dollar amount should be indicated, also how it will be held, i.e., separate account and when it is returned, i.e., after an inspection of the premises once the lessee has vacated the premises
- Amount of the Rent – specify the amount of rent in numerical terms and also written out
- Payment Deadline – specify when the rent must be paid each month
- Release of Percentage Rent – some agreements link the total rent to the sales revenue of the lessee. If this is not the case, mark it invalid
- Percentage Rent Requirement – if the agreement is linked to sales, indicate this article and the percentage to be included in addition to the base rent
- Owed Percent of Revenue – include the percentage of the lessee’s revenue to be used in the calculation of rent due along with the type of revenue to be included.
- Percentage Rent Deadline – the base rent may be expected to be paid monthly; however, the rent based on revenue could be expected to be paid monthly, quarterly, or annually.
- Late Rent Payment Penalty – specify the number of days the rent can be late before a late fee is assigned and collection begins.
- Penalty Percentage – if the late fee is agreed to be a percentage of the rent, specify the percentage and how it is calculated, i.e., a percent of a month, quarter, or a year.
- Penalty Dollar Amount – if the late fee is agreed to be a dollar amount, indicate the amount in dollars
- Gross Lease – is the full amount of money expected by the lessor
- Modified Gross Lease – if additional payments are required, the amounts should be specified in this section
- Modified Payments – may include additional fees such as waste disposal or water bills and should be specified clearly in this section
- Triple Net – indicates the lessee is expected to pay for all taxes, insurance, maintenance, and utilities.
- Death or Injury Insurance – add this clause if you want the lessee to purchase death or injury insurance to protect the lessor from damages associated with injury or death on the property
- Insurance for Property Damage – add this clause if the lessor wants the lessee to purchase property damage insurance to protect the lessor from property damage
- Casualty Insurance – add this clause to add casualty insurance that the lessee must maintain
- Lessee May Not Renew – indicate that the lessee may not renew the lease or
- Lessee May Renew – indicate that the lessee may renew the lease
- Renewal Term – indicate the number of times the lease can be renewed, including the number of years and months for each renewable term
- Rent Renewal – indicate if the term is to be renewed at the same rent level or increased
- Bureau of Labor Statistics Increase – rent can be renewed based on the CPI (Consumer Price Index) or
- Rate Increase Renewal Percentage – rent increases based on a percentage of the previous rent or
- Flat Dollar Amount Increase – rent is increased by a flat dollar amount.
- Leasehold Improvements – improvements may be required from time to meet local laws, to maintain the lessee’s business to be competitive, or for many other reasons. The lessee or the lessor may be responsible for these improvements as per the agreement outlined in this section.
- Governing Law – name the state that the property is located in and verify that the laws of the state are being followed.
- Lessor Information – provide an address where notices may be sent to the lessor
- Lessee Information – provide an address where notices may be sent to the lessee
- Terms & Conditions – Additional – terms and conditions may be needed to cover the type of business, the property, or the state the property and business are located. There may be special conditions needed by the lessee or the lessor. They should be captured in this section.
- Signature – Lessee, Date, printed Name – provide space for the lessee to add their signature, the date, and their printed name. In addition, all articles should be initialed, particularly rent numbers and penalties.
- Signature – Lessor, Date, Printed Name – provide space for the lessor to add their signature, the date, and their printed name. In addition, all articles should be initialed, particularly rent numbers and penalties.
- Acknowledgment of Notary Public – the commercial lease agreement should be signed in front of a notary public to witness the agreement and notarize the agreement.
- Lessee – the lessee, should sign an acknowledgment that the agreement has been notarized
- Lessor – the lessor, should sign an acknowledgment that the agreement has been notarized
Types of Commercial Property
There are common types of commercial property, and it is important to market your property to the correct market. For example, marketing a warehouse space to a retail customer group would not have much success since the retail customer is looking for a retail location and structures that are conducive to retail operations.
The common types of commercial property fall into the following categories:
- Industrial space
- Office space
- Retail space
Industrial space – includes warehouses, factories, heavy and light manufacturing, often close to transportation routes and outside cities. They must meet local codes suitable for warehousing and manufacturing. These include heavy manufacturing, assembly, warehousing, and R&D facilities
Office space – can be found in the suburbs as well as in the downtown core of cities and towns. The space is used to manage business operations and is usually populated with people performing operations that keep a company’s business operations flowing. There are several classes of office buildings with corresponding lease requirements.
Retail space – is usually associated with shopping in shopping centers, strip malls, small mom-and-pop shops, and restaurants. Leases can become complex, especially if there is a lot of shared space between tenants, e.g., parking, hallways, utilities, etc.
The details in the commercial lease will vary a great deal depending on the number of clients in a building space, how much is shared, and the type of space that is being leased. Most businesses focus their efforts and investments on operating their business and use rented properties instead of purchasing the property that ties up huge sums of capital.
How to Lease Commercial Property (Step-by-Step)
Properties are unique in terms of location, features, including space available, parking, finished or unfinished, and a variety of other factors. Many properties are rented based on a cost per square foot. Just as in residential real estate, comparing your property to others on the market helps to establish a price. Once you have set a price for your property, it is time to advertise it for rent, sign a lease, and collect the rent.
There is a standard step-by-step process that works well for many commercial landlords, which is summarized below with more details reviewed for each step.
- Establish how much space is available.
- Determine the price you will advertise per square foot
- What lease type will you offer?
- How will you market the property?
- Listing the property
- Lease negotiations
- Complete credit checks
- Tenant approval
- Security deposit
- Prepare the commercial lease agreement
Establish how much space is available – measure the length and width of the useable interior space. Multiplying the two gives you the number of square feet available for use. You may also want to measure parking space if parking is also included.
Determine the price you will advertise per square foot – perform a competitive assessment to ensure that you position your price per square foot close to other properties in the area with similar value propositions.
What lease type will you offer?
- Gross – the tenant only pays the lease amount
- Triple – the tenant is asked to pay taxes, utilities, and maintenance costs, including insurance coverage of the property
- How will you market the property? – paying a real estate company increases your costs; however, in difficult markets, it can mean the difference between a vacant property and one that is fully rented. Markets with low vacancy rates are often easier to market on your own due to high demand.
- Listing the property – while a real estate firm will look after listing the property on several listing websites, including their own, listings managed by the owner must be handled by the property owner. Make sure you have great pictures that show your property at its best, including common and shared areas. List all of the amenities, including access, parking, and utilities that are included.
- Lease negotiations – anticipate negotiations to cover every area of the lease. Identify any sticking points for the prospective tenant and look for ways to negotiate a win-win solution. In tight markets, you may not feel the need to offer flexibility in your negotiations, while in high vacancy markets, getting creative with a tenant and finding solutions to solve issues can make the difference in leasing your property.
- Complete credit checks – on both the individual and the company, especially when dealing with small businesses and entrepreneurs. Larger companies should still be reviewed; however, the level of risk is perceived to be lower for large companies. Business credit checks and individual credit checks are easily performed, and the cost is well worth it.
- Tenant approval – now that you have all of the details worked out, it is time to approve or disapprove the tenant. Keep it professional and issue a tenant rejection or approval letter to the tenant. You may also ask for a personal guarantee to bind the owner of the business to the lease if the tenant’s business fails and they are unable to meet their monthly obligations.
- Security deposit – one major difference between residential and commercial rent agreements is that there are no limits to how much a landlord may ask a tenant for a security deposit. Typical security deposits range around 2 to 3 months of rent. This is also a competitive factor and might be waived in a high vacancy market.
- Prepare the commercial lease agreement – either prepare the agreement yourself or hire a lawyer to draft the agreement. The draft should reflect all of the terms and discussions you have had with the tenant. At this stage, there should not be any surprises. Both parties should sign the commercial lease agreement in the presence of a notary to prove the signatures if the lease is ever contested in the courts.
- Occupancy – once the lease is signed and the security deposit is cleared, the tenant should be handed the keys and can take occupancy of the building. Both parties are held accountable to meet the terms of the lease agreement.
The following are several frequently asked questions many lessees and lessors may have with respect to commercial lease agreements.
Does a commercial lease agreement have to be in writing?
The commercial lease agreement must be in writing, initialed, and signed by the lessee and the lessor. The signatures should also be notarized by a notary public.
What is the most common type of commercial lease?
There are many different types of leases; however, the most common types of leases include the triple net lease, a modified gross lease, and absolute net leases.
How long does it take to negotiate a commercial lease?
The length of time needed to fully negotiate a commercial lease depends on many factors, such as the complexity of the lease, how competitive the business arrangement is, and whether there are any sticking points that either the lessee or the lessor cannot agree to. The lessor should have all of the required data available such as the number of square feet, utility costs, taxes, insurance costs, etc., if these items are to be negotiated and included in the lease.
How is a commercial lease calculated?
The base rent for a commercial lease is usually calculated based on the number of square feet being leased. Other factors may be added to the base rent depending on the negotiations, such as taxes, maintenance, insurance, improvements, utilities, and whether the rent is based on the success of the lessee’s business, either as a percentage of the income or the profit.
Commercial lease agreements document the arrangements between a lessor and a lessee to rent a property. The details include rent levels, the penalty for late payments, who pays taxes, insurance, utilities, and insurance, how the property will be used, and any restrictions. There are many different details that, once clarified and negotiated, provide protection for both parties.
A lease agreement should be signed by both parties in the presence of a notary public to provide official support for the agreement if the agreement ever needs to be contested in court.
Commercial lease agreements can be negotiated quickly unless there are too many points of contention concerning property use, rental costs, associated fees for taxes etc., renewal clauses, and many others. Aim for a win-win discussion to enhance the negotiation process.
Commercial lease agreements can be tailored to the type of property, which falls into retail, warehousing, and manufacturing space. Each area has its own specific needs and requirements for both landlords and lessees.