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Beginners Guide to Commercial Lease Types

Blaine Annett
I
December 22, 2021

Beginners Guide to Commercial Lease Types


A commercial lease is a legally binding agreement between a landlord and a tenant.


Although representatives on either the tenant or landlord side of an agreement may negotiate them, the owner/landlord ultimately signs as the lessee—the tenant signs as lessor.


A lease agreement grants a tenant certain rights concerning a building.


The most important determinant of these rights is usually the lease agreed upon by the landlord and tenant.


Different lease types have various benefits for businesses and property owners. This is dependent on the type of business, location, and goals of the owner.


This article will discuss the various types of commercial leases and the terms and conditions that come with each agreement.


Types of Commercial Leasing


Single Net Lease


Perhaps the most commonly used form of commercial leasing agreement is the net lease.


A net lease requires the tenant to pay a rent payment and other expenses.


You might be charged additional fees, such as:


  • Utilities
  • Insurance
  • Property/building maintenance


This works in a similar way to renting a single-family home. First, the landlord pays the mortgage, and the tenant pays the rent. After that, the tenant is responsible for paying the utilities and maintaining the property.


However, a net lease is available in many forms and has different layers of responsibility for tenants.


A single net lease, also known as an "N" lease, is the simplest net lease form.


In a single net lease, The tenant pays both the rent and the property taxes associated with the space they rent.


Single net leases are the least common type of lease structure in commercial realty.


The only reason a landlord would choose a single net lease over a gross is to ensure that property taxes are paid on schedule.


A single net lease lets the landlord collect funds used to pay property tax, and then the city can pay them directly.


Double Net Lease


A double net lease or "NN" leases place the renter in charge of the base rent and property taxes as well as the cost of building insurance.


This type of agreement allows the landlord to continue responsible for utilities, maintenance, and other related costs. In multi-tenant buildings, double net leases are standard.


In this way, the landlord will be responsible for any structural problems that arise on behalf of all tenants. The landlord will generally charge each tenant property taxes and building coverage according to their total leased area.


Triple Net Lease


The triple net lease or "NNN" leases are popular among commercial landlords. This lease places the tenant on the hook for most of the cost, including the base rent and property taxes.


This includes repairs to the property that is associated with the commercial space.


Triple net leases mean that the tenant is responsible for the cost of fixing a roof that leaks. A NNN lease tenant will typically pay a lower base rent per square foot because of the additional costs.


Triple net lease properties are often owned and managed by investors who prefer a hands-off approach.


Bondable Net Lease


Bondable net leases are a variation on the NNN lease that places every possible risk associated with the property on the tenant.


For example, if the property were set on fire, the tenant would need to rebuild it and continue paying rent to a landlord.


For any reason, bondable net leases cannot end before the expiration. If major structural repairs are required under a NNN lease, landlords may use bondable net leases to protect themselves.


Full Service Gross Lease


A full service gross lease means that the tenant pays a fixed rent every month. The landlord is responsible for covering all costs related to operation and maintenance.


O&M expenses typically include insurance, utility management, and tax.


Full service gross leases can be compared to an all-inclusive resort. One flat fee is charged, and all amenities are included.


Modified Gross Lease


A modified gross lease is very similar to a full-service lease, with one exception. Modified gross lease type puts the tenant on the hook for additional building owner costs not included in the base year.


The tenant might be required to pay part of any increase in property taxes if the city decides to raise them.


Percentage lease


A percentage lease is the most common and used by retailers and restaurants.


Tenants who sign a percentage lease are expected to pay a basic rent (or a minimum amount) in addition to a percentage of the business's income. Accordingly, the rent payment will be calculated as follows:


Rent Payment = Base Rent + % Of Gross Profits


Each party must agree to the percentage before signing.


The "natural breakpoint" is often used to calculate percentage leases. This type of commercial lease calculates a natural breakpoint by dividing the base rent by an agreed percentage.


The annual base rent is divided by the percentage to calculate the tenant's share of the rent.


Example:

The shopping center owner signs a percentage lease agreement with a nationally-branded furniture retailer. The center's anchor is the furniture store. The furniture shop pays a base rent annually of $500,000.


They agree to pay a percentage of rent equal to 5% above the natural breakpoint. In other words, $500,000 / 5%.


This would amount to $10,000,000. The furniture store would be paying $125,000 more if it had gross sales of $12,500,000 in a given year.


This number can be obtained by taking the amount above the natural breakpoint, or $2,500,000, and multiplying it with 5% to get $125,000.


Other ways of setting percentage leases are possible. For example, rent may be set as a percentage or a percentage of gross revenue.


This is more common with short-term leases and when a startup business cannot guarantee a certain amount of sales.


It could also be used when a company is going through difficult times (e.g., because of a recession) and expects to see business pick up in the coming years.


This scenario could mean that the business cannot pay a significant base rent but can offer a higher percentage scale as its business grows.


Typical terms for commercial leases


The length of commercial leases is subject to variation.


Many leases are month-to-month. This is especially true when it comes to smaller commercial properties. Other lease terms are for more extended periods, such as 30+ years.


It really depends on the property, how big the business is, and how long it has been in business.


Commercial leases typically take one of these forms.


Fixed End Date


A fixed-end date lease gives each party assurance about when the tenancy ends.


All terms of leases remain the same throughout this period. The other party does not need to give notice before ending the lease. The lease is terminated at the end.


Automated Renewal


Some leases automatically renew after a specific period unless the other party gives notice in advance.


A salon owner might sign a one-year lease that automatically renews every January.


The lease terms (including rent payments) will remain in effect unless the lease agreement is changed.


Lease Options


There are two options for leasing: an auto-renewing or fixed-end lease.


Commercial leasing agreements stipulate that the tenant will occupy the premises for a specified period.


A tenant has the option to extend their lease up to a certain length at agreed terms after this period ends.


Software engineering companies might sign a five-year lease to occupy space in an office building. After their initial lease expires, they can renew their lease for an additional five years.


The landlord will usually include a rent-escalator to ensure that the landlord receives an increased rent payment if the company renews its lease.


This gives both parties predictability and flexibility.


Property Intelligence - Analyzing and Understanding Commercial Tenants


You can learn a lot from the type of lease on commercial properties.


Property intelligence makes it easy to find tenants, spaces, or both quickly.


If you are looking to learn more we can help you out at A Street Partners.


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