Understanding Commercial Real Estate Leases
When listing a property for sale or lease, you need to understand the type of lease you are dealing with. There are definite differences in leases at all levels and therefore a lease should be read in its entirety before proceeding.
Leases are the foundation of property performance. The best salespeople understand the leasing process and the high value it brings to the future sale. A good lease can improve the sale price when the time comes.
As mentioned, there are many different types of leases, but there are some common basic rules and elements that will help you understand the lease or potential lease that may apply to a property. It is about the interpretation of the lease document and that means you have to read the document.
Professional real estate services
After many years of working in the industry, I have seen the best people lay the foundation for success around the leasing process. This means that they have been building on investment skills and knowledge by leasing properties for a few years. So now let’s see how you can move forward on this path of skills development when it comes to leasing.
The better you negotiate and more fully interpret a lease, the more professional you will be and appear to the people you work with or serve.
You can and should add strategic customer value to every lease you negotiate. A lease is not just a document to allow a tenant to occupy a premises; it is a tactical cash flow that can attract or detract from the property.
The way leases work for the real estate investor will have a solid impact on the property and its performance over the duration of the lease. As you work with tenants or buyers of the property, the type of lease that applies will also have an impact on the negotiations. Let’s look at the main types of leasing and expand on some of the topics most relevant to you.
Gross lease:
In a gross lease, the tenant pays a full rent that includes a component for expenses, and the building owner will pay all of the building’s operating costs (also known as expenses). This means that the lease itself will have rent review provisions that increase the gross rent only.
In such a lease, the lessor should know that he can keep building expenses at predictable levels for the term of the lease, as the lessor bears all the risk of paying the expenses. The rent review escalation levels in the lease should be expected to cover or exceed the expense level escalations in future years, or the landlord will lose money.
Gross leases are common in commercial and office properties. Your choice in using this type of rental and lease should be balanced with the anticipated levels of exit costs and future changes for the property in question.
Obviously, an older building will have constant increases in expenses over and above those of a younger building. As a building ages and deteriorates, the gross lease method becomes less attractive and more risky for the owner.
Semi Gross Lease:
In this type of lease, the landlord initially establishes a gross rent that is paid by the tenant and is reviewed over the term of the lease, however, the landlord also receives a regular payment for expenses that increase based on a specific calculation. This is how you do it:
The lessor specifically recovers the expense escalation above a nominated expense base year. This base year is selected at the beginning of the lease and is generally the last reconciled year before the beginning of the lease, which is generally the financial year before the beginning of the lease (because it is fully reconciled and is known as a set value).
As the new semi-rent lease progresses through its term, the tenant has to pay for escalating expenses above the designated base year. For example, if in a lease the base year for expense purposes was set as financial year 09/08 and the known level of expenses for that year was $ 85m2 pa, then in financial year 09/10 when expenses escalate at $ 97 m2, the tenant must pay expenses of $ 12m2pa. As the lease ages and in the 12/13 financial year, the expenses could be $ 108m2, in which case the tenant will have to pay $ 23m2.
In this type of lease, the base year is set and the expense ‘gap’ is likely to increase significantly as the lease ages. This type of lease is good for the landlord with younger properties as it protects the landlord against escalating expenses above the base year while allowing the landlord to use gross rent as the basis for collection and the collection of the rent.
It is common in this type of lease that the base year of expenses is updated at the time of any market rent review during the lease. Market reviews in this type of lease would be done if the lease was long (more than 3 years) and therefore the market rent review would be done, say, every 3 or 4 years.
It is not necessary to do a market rent review at a particular point in time in a lease, as the matter is negotiable at the inception of the lease, however, be aware of resetting the basis for expenses and impact you will have in the owner.
As an additional interpretation of this type of lease, you should look at the type of expenses that are recovered in the calculation. It is not unusual for “expert leasing tenants,” such as the government or large corporations, to designate the type of expenses to which base year escalations will apply.
Naturally, it is better for the owner to recoup the escalation in all expenses in a building above the base year, however the government and corporate tenants are well known for limiting the calculation to rates and tax scales.
Clearly, a lease is the product of negotiation, but you need to understand what to do and then get the best possible lease for your client.
Net leases:
The term net lease is, first of all, generic; therefore, you should be aware that there are 3 types of net leases within the category. So let’s see them.
Net lease: In this lease, the tenant pays some or all of the property or premises fees and taxes.
Net-Net Lease: In this lease, the tenant pays the fees and taxes listed in the “net lease” method, but then also pays the property and premises insurance premiums.
Net-Net-Net Lease: In this lease, the tenant will pay the fees and taxes, insurance for the premises, and then also pay for the repair and maintenance costs associated with the premises.
So what type of lease is best for the landlord? In most cases, the Net-Net-Net Lease is the way to go, however it is a question of whether the tenant will accept and sign that type of lease.
As a point of negotiation, it would be prudent in any Net Lease, or Net-Net Lease to have a higher initial rent for the landlord and better rent review provisions that compensate for the lower cost recovery for the landlord.
Net-Net-Net leases are common on properties that are fully tenant-occupied. This method of leasing structure is widespread in industrial property and office property.
Lease percentage:
This type of lease is most commonly seen in commercial properties, as the rent calculation is tied to the tenant’s business figures. In most leases of this type, the tenant first pays a fixed base rent that is geared to some method of rent review, and then the tenant also pays an additional rent that is calculated from his volume of business or sales. As the tenant improves his business, the rent increases.
An essential part of this lease structure is forcing the tenant to provide accurate and regular audited billing figures. The lease must support and enforce the audit process for the owner. Monthly billing figures are the best way to go, as the tenant provides the audited figures to the landlord, say, on the 7th of the following month. The landlord then collects the billing rent from the tenant based on the audited figures.
This type of leasing is also seen in new shopping centers as new tenants stabilize customs and sales levels, in supermarkets for the same reasons, and in hotels or motels. The basic strategy with rotating rental is to give the landlord some cash flow from establishing a base rent from the beginning of the lease, and then charging an additional rent as the property and lease become more successful in generate sales and customers.
Spell it
In all leases, the recovery of rent and expenses must be clearly established to avoid debates and disagreements with the tenant. As you can see now, the selection of the type of lease to use on a property will have a significant impact on the future of the owner. It will also affect any sales situation.
It is worth knowing what is happening in the market when it comes to the types of leases and rentals so that you can make lease agreements that are similar or better than the rest of the market. The correct lease structure, document and rent will help sell properties at better prices.