A Commercial Tenant's Guide to Lease Terms
Most Area Development readers are well-versed in the terms of industrial leases, but potential inconsistencies and new issues make a review well worth your time.
Jennifer Malmar-Rogers (Dec/Jan 08)
You're facing a major lease agreement. The lease document is lengthy and written in mysterious "legalese." How do you know what the terms really mean and what the implications are for your business? A misunderstanding or overlooked issue today can become an expensive problem in the future. So it's useful to be able to interpret the terms of today's industrial lease documents.
The conventional wisdom is that leases are written to benefit landlords more than tenants. It's no surprise that landlords need to protect their interests just as much as tenants do, and no secret that brokers are typically paid by the landlords. However, with an understanding of your lease document - and representation by an ethical, skilled broker working on your behalf - you can secure a lease agreement that is a win-win for both parties in the transaction.
Types of Leases
One confusing aspect of leasing is that even industry insiders can be inconsistent in their descriptions of the various kinds of leases. Most industrial facility leases are a variation of "gross" or "net." Net leases are commonly used for single-tenant industrial properties, while modified gross leases are typical in multi-tenant facilities. These terms refer to how roles and responsibilities are divided between the landlord and the tenant, how various property expenses are paid, and who pays them.
With a full-service gross lease, the tenant pays a lump-sum monthly rent to the landlord, and the landlord in turn pays for taxes, maintenance, insurance, and utilities. The tenant also must pay for any additional property insurance, taxes or utility expenses incurred by their occupancy, and for their share of any future "pass-through" increases in property operating expenses.
A modified gross lease is common in industrial facilities. It is similar to a full-service gross lease, but certain operating expenses - e.g., real estate taxes, electricity, maintenance, or janitorial services - are paid directly by the tenant. This lease structure is useful if each tenant has a different business and has different needs, and/or if some utilities are directly controlled by individual tenants.
Like gross leases, net leases come in several varieties. A net lease requires the tenant to pay some or all of the property expenses directly to the source - whether a service provider, tax authority, or insurance company, for example. Since there are no set standards as to what costs may be excluded or included in a net lease, the lease is usually customized according to need.
With a single-net lease, the tenant pays a monthly lump-sum base rent as well as the property taxes. The landlord is responsible for all other operating expenses of the property and the tenant's premises.
With a double-net lease, the tenant pays a monthly lump-sum base rent as well as the property taxes and the property insurance. The landlord is responsible for all other operating expenses.
A triple-net lease, often used with single-user industrial facilities, means that the tenant pays "TMI" - taxes, maintenance, and property insurance. Tenants also are responsible for all costs associated with their occupancy, including personal property taxes, janitorial services, and all utility costs. The landlord is responsible for the roof and the structure, and sometimes the parking lot. If you are considering a triple-net lease, it's important to clarify the parking aspect up front or risk disputes down the road. A triple-net lease gives the tenant near-total control over the property, as long as they comply with the use limitations and other clauses specified within the lease. The disadvantage is that triple-net leases often cannot be cancelled except under extreme situations, such as an eminent domain ruling.
An absolute triple-net lease or bond lease is triple-net lease with one key difference: under no circumstances can a tenant cancel the lease. Property investors and lenders like bond leases, for obvious reasons, but the arrangement works only if the tenant company is reasonably expected to have a long lifespan.
Length, Holdovers, and Options
Landlords like long-term leases and will offer a lower rent rate and more concessions for a lease of 10 years or more. Companies, however, prefer flexibility, especially given the fast-changing pace of today's global economy. Many tenants aim for the best of both worlds by assuming a long-term lease with a cancellation option if at all possible. Some landlords will require a certain amount of notice or other compensation to minimize potential loss of income from vacancy.
On the other hand, industrial leases today often have shorter life spans than in the past. You will likely pay a relatively high rent for a lease of five years or less, but for some companies under certain conditions, the higher cost makes good business sense.
You also can request an option or options to extend the lease at a rental rate structure that you should negotiate up front. Typical arrangements include continuing per lease terms, continuing at a rate adjusted by a certain percentage, or continuing under prevailing market conditions.
Another lease length issue to consider is a possible holdover - staying in your space an extra one or two months beyond the lease expiration date. Landlords typically require holdover rent that is 200 percent of the last month's rent, but you may be able to negotiate a somewhat lower rate.