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Renting space for your business is a big step. So, before you sign anything, it’s important that you understand and agree with the basic terms of the lease, such as the amount of rent, length of the lease, and what other costs (like property insurance and taxes) may be involved.It's also important to understand that commercial leases are typically very different from the residential variety. In general, commercial leases offer fewer protections, have longer lease terms, and offer more room for negotiation than residential leases.Here are some key things to keep in mind when renting space for your small business, plus tips on how to negotiate the best lease deal for your company’s needs.
What Is a Commercial Lease Agreement?A commercial lease agreement, or business lease agreement, is a legally binding contract between a landlord (the “lessor”) and a tenant (the “lessee”) for the rental of a commercial space or property. The term “commercial” means that the space will be used for business purposes rather than housing. A commercial tenant could be a sole proprietor just starting a company or a large global corporation.A commercial lease outlines what that tenant is expected to pay, what type of business or activities may take place in the rental property, as well as how long the space is to be rented. Recommended: What You Need to Know About Commercial Real Estate Loans
How Does a Commercial Lease Differ From a Residential Lease?Aside from the main difference between commercial and residential lease agreements — the former referring to business and the latter to private rentals — there are several other key distinctions. Here’s a look at some of the ways in which commercial leases can differ from residential leases.
- No standard form Commercial leases typically aren’t based on a standard form or agreement but are customized to the landlord's needs. As a result, it’s a good idea to carefully examine every commercial lease agreement offered to you.
- More flexibility Typically, there’s not much negotiating in a residential lease and landlords typically use a standard residential lease agreement. Commercial leases are generally subject to much more negotiation between the business owners and the landlord.
- Longer and more binding Unlike residential leases, which typically last one year, commercial leases can last for several years. A commercial lease also tends to be harder to break than a residential lease.
- Fewer legal protections Commercial lessors and lessees have less legal protection than the residential ones because the state and consumer laws typically apply to residential leases only. With a commercial lease, the tenant generally has no rights other than what is explicitly stated in the lease agreement.
- Tenants may be responsible for property taxes Renters in a residential lease agreement are usually not responsible for paying property taxes, whereas with commercial lease agreements, it's very common for the tenant to pay at least a portion of the property taxes.
What Are the Different Types of Commercial Leases?Commercial leases can be structured in a variety of ways, depending on the type of property, type of business, and number of tenants. In some cases, the tenant is only responsible for rent; in others, the tenant is responsible for all costs, including property insurance, property taxes, and maintenance and repairs of the building. Generally, if a tenant is required to assume most of the building’s costs, the rent will be lower.Here’s a look at some of the most common types of commercial lease structures.
Net LeaseThe tenant pays rent, plus a percentage of the building's operating costs, which includes insurance, maintenance fees, and real estate taxes. There are three types of net leases: single, double, and triple.
Single Net LeaseThe tenant pays rent, utilities, and property taxes. They do not pay any insurance or maintenance costs (that is the responsibility of the landlord).
Double Net LeaseThe tenant pays rent, utilities, property taxes, and insurance. Maintenance expenses are paid by the landlord.
Triple Net LeaseThe tenant pays rent, utilities, property taxes, insurance, and maintenance expenses.The maintenance expenses typically aren’t all inclusive, however. The landlord is generally still responsible for maintaining the structural components (structural walls, foundation, and roof) of the building.
Absolute NNN LeaseThe tenant pays rent, utilities, property taxes, insurance, maintenance fees, and all upkeep of the building.
Gross LeaseThe tenant is only responsible for rent (and, possibly, utilities). They are not responsible for property taxes, insurance, or maintenance costs. Because of the increased risk on the part of the landlord, the rent will typically be higher with a gross lease than with other types of commercial leases. However, if you’re just starting a small business, having a predictable payment may be an advantage.
Percentage LeaseThe tenant pays a static monthly rent, as well as a percentage of their monthly sales. A common amount is 7%.
What to Look For In Your Commercial LeaseBefore you sign on the dotted line, it’s important to read the fine print of a commercial lease and make sure the terms meet your business's needs. Here are some things to look for — and look out for — when combing through a lease agreement.Duration of the lease Businesses often have multi-year commitments as opposed to just one year. Make sure you understand how long you are agreeing to rent the property. Space you are renting What is the exact space that you are renting? Does it include common areas such as hallways, rest rooms, and elevators? Penalties What are the penalties for paying the rent late? How long do you have before you accrue any fines?Rent amount Is the rent amount what was discussed between you and the landlord? If it’s more, don’t be afraid to ask why. Also don’t be afraid to negotiate, even at this stage of the game. Negotiating commercial leases is common and often takes place until just before the contract is signed. What happens at the end of the lease term Does the lease expire after the term length passes, or will you have an option to go month-to-month or renew it for shorter periods of time? Utilities Who is responsible for paying the monthly utility bills, such as gas, electricity, and water? Depending on the type of lease you have, you may be responsible for everything, nothing, or only a portion of the cost of utilities. Building maintenance Are you responsible for lawn care, snow removal, or the overall maintenance of the parking lot and building? If you are being allocated a percentage of maintenance fees based on the percentage of the building you're renting, be sure the percentage is based upon the overall size of the building and that it doesn't vary based on how much of the building is rented out at any point in time.Specifications for signs Can you hang signs and, if so, where?Insurance Who is in charge of insuring the building? Many types of leases make it the tenant’s job to insure the building’s structure. It may be outlined in the lease that the landlord expects you to get commercial property insurance. Alterations to the space Are you allowed to make any changes or modifications to the building or space you are leasing? If you are, what is expected of you after your lease ends?Security deposit The security deposit is paid by the tenant to the property owner when signing the contract. The lease agreement should specify the amount that was paid in regards to the security deposit and the terms for its repayment.Taxes Are you expected to pay property taxes on the building? If so, are you expected to pay the entire amount or a percentage? Personal guarantee Typically, a landlord won't sign unless you personally guarantee the lease. However, you may be able to negotiate the nature of the guarantee. Maybe you can provide a guarantee for only a portion of the lease term or arrange that the guarantee only last for six to 12 months after you terminate the lease.Rent increases Generally, rent for commercial property increases by a predefined percentage each year. However, you might be able to negotiate a longer time between increases.Subleasing Are you allowed to sublease? A sublessee is another business that works in your lease space under your lease terms. You pay the lease and the other party pays you a portion of the cost. Many landlords don't allow sublessees, but you may want to negotiate this if you think you might want to take on a sublessee at some future point in time.
Common Terms In Your Lease, ExplainedLessor: Landlord, or the person who owns the space that is being rented.Lessee: Tenant, or the person renting the space outlined in a lease. Parties: Those who are signing the lease (landlord and tenant, or lessor and lessee).Premise: The space that is being rented.Use Clause: Outlines what can and cannot be done in the space being rented.Exclusive Clause: Promise by a landlord that no one else in the building or mall may sell or carry out a certain kind of business that would compete with your company.Term Clause: Specifies how long the lease is, or how long you will be able to use the space you are renting. Incidental Expenses: Other costs besides rent that a tenant agrees to pay. This includes things such as insurance, utilities, property tax, maintenance and repairs.CAM: This refers to “common area maintenance,” and can include costs for services such as landscaping, grass cutting, snow removal, and janitorial services, which are often shared among tenants in a building. Escalations: Rent increases.
How Does Your Loan Factor Into Your Lease?When leasing commercial real estate, landlords will generally require some sort of financials and credit information about your business, as well as you personally.If you currently have a business loan, your loan payment comprises part of your debt-to-income (DTI) ratio, which shows how much of your business’s income is being spent on debt payments. A commercial landlord may look at your company’s DTI (which is part of your credit report) when evaluating your lease application in order to be sure you will be able to pay the rent.As a business owner, you’ll also want to look at any existing debt when determining your budget for a business lease. If you are currently making monthly loan payments, you'll want to make sure you can comfortably sustain both payments (your loan along with your commercial rent) before signing a lease.Recommended: Small Business Loans for Rental Property
The TakeawayUnlike residential leases, there are many different types of commercial lease agreements that offer flexibility based on the needs of your business. Each one comes with its own pros and cons, so it’s important to read the lease agreement carefully before signing. You can also hire an experienced lawyer to help negotiate a lease on your behalf, especially if the terms are complex.
3 Small Business Loan Tips
- Generally, it can be easier for entrepreneurs starting out to qualify for a loan from an online lender than from a traditional lender. Lantern by SoFi’s single application makes it easy to find and compare small business loan offers from multiple lenders.
- If you are launching a new business or your business is young, lenders will consider your personal credit score. Eventually, though, you’ll want to establish your business credit.
- Traditionally, lenders like to see a business that’s at least two years old when considering a small business loan.
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About the Author
Lauren WardLauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.