Commercial Lease Agreement: Key Terms, Types
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What is a Commercial Lease Agreement?
A commercial lease agreement is a legally binding contract executed between a landlord and a tenant (typically a business owner) for the purpose of renting property for retail, office, or industrial use. The designation of “commercial” means that the property will be used strictly for business purposes, and annual rent is based on price per square foot ($/SF) plus any operating expenses.
Many business owners choose to rent property rather than purchase property because it requires less capital. Commercial tenants can operate any kind of business whether it is a small sole proprietorship or a large corporation.
Commercial leases tend to be more complicated than a residential lease and there are certain terms that a landlord and tenant should be sure are included in the agreement. Common lease lengths are between 5-10 years with options to renew at pre-set rates.
For a more information and definitions of a lease, read this article.
What's Included in A Commercial Lease Agreement?
Commercial lease agreements are usually negotiable and need to fit the needs of the tenant’s business. Each lease will vary depending on the landlord and tenant’s requirements, but most commercial leases will include the following common terms.
- Cost of rent: The monthly rent amount is usually the biggest concern for both landlord and tenants. The business lease agreement should clearly state the agreed upon monthly rent, the due date for rent, and what utilities, taxes, and insurance the tenant is responsible for.
- Length of lease: Length of lease can vary depending on the needs of the business and landlord. Landlords generally prefer longer leases to ensure consistent payment while a new business may feel safer with a shorter lease. Many leases start out with a term for one year with an option to renew.
- Security Deposit: It is common for a landlord to require a security deposit due at the signing of a commercial lease. The lease should include information about the amount and return procedures of the deposit.
- Property Description: The property that is to be rented needs to be clearly and accurately described in the lease. It should include information like the property address, size of the space, common areas, and parking availability.
- Rent changes or increases: Usually commercial leases will include terms regarding annual percentage-based rent increase. This can normally be negotiated between the tenant and landlord.
- Business signs: A business owner will need to have signage on the property to promote their business. It is important that lease doesn’t prohibit signs on the property and gives details about what kind of signs and what size signs are allowed.
- Improvements or repairs to the property: Another common term in commercial lease agreements addresses whether improvements or modifications can be made to the property. This clause will include who is responsible for payment of improvements and whether the tenant needs to return the property to the original condition at the end of the lease.
- Subletting: Many businesses request the option to sublet the commercial space to a third party. This is because even if the business fails, the tenant will still be responsible for the commercial lease agreement. All terms relating to subletting the property should be laid out in the lease agreement.
- Use clause: A use clause is included in a commercial lease agreement to dictate the kind of activity that the tenant can engage in on the property. This protects the property and the landlord from damages and liability. A tenant is going to want a broad usage clause to allow different kinds of activity on the premises.
- Exclusivity clause : A exclusivity clause is very important for a tenant to have included in a commercial lease if the rental property is in a complex with multiple units. This prevents a landlord from renting additional units to the business’s competition.
Many commercial leases will also contain a clause about the Americans with Disabilities Act. This requires that business spaces open to the public must be accessible to people with disabilities.
It is generally the tenant’s responsibility to make sure their business meets all ADA requirements. The lease should include terms that allow a tenant to make upgrades to stay compliant with the ADA.
Landlords and tenants can include any other terms in a commercial lease agreement that they deem necessary for their rental agreement. A commercial lease agreement is a legally binding contract so all terms will be enforceable. The only unenforceable terms are those that are illegal or too vague.
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Common Types of Commercial Leases
There are various types of commercial leases in addition to the standard annual lease agreement. Other types of commercial lease agreements include the following:
- Net Lease : In a Net Lease, the tenant is responsible for paying most, if not all taxes, insurance, and maintenance costs on top of the agreed upon monthly rent.
- Double Net Lease: A Double Net Lease requires the tenant to pay all taxes, insurance, and the monthly rent.
- Triple Net Lease : In a Triple Net Lease, the tenant pays for the taxes, insurance, maintenance, and rent.
- Absolute Triple Net Lease: An Absolute Triple Net Lease absolves the landlord from any responsibility for paying for taxes, insurance, and maintenance. Some expenses that the tenant will be required to cover could include repairs to a building’s roof or main structure.
- Percentage Lease : If a tenant signs a Percentage Lease, they will pay a base rent amount in addition to a percentage of their sales and profits.
- Fully Serviced Lease: A Full-Service Lease, also called a Gross Lease, states that the rent amount is inclusive of utilities and all other services that a tenant would normally have to pay for separately. This is usually used for a short-term lease agreement.
A commercial lease agreement should clearly state which type of lease is being used and how rent is calculated, especially for a Percentage Lease.
This article goes into further detail about Single, Double, and Triple Net Leases.
What Properties Are Considered Commercial?
Generally, for a property to be considered commercial, it needs to be non-residential. In other words, the property should not be used as the place of residence for tenants. Below are some examples of commercial properties:
- Office Space
- Retail Stores
- Industrial Buildings
- Warehouses
- Restaurants
When A Commercial Lease is Needed
A commercial lease should be executed anytime a business owner is going to rent a property for the purpose of running their business. Commercial leases are binding contracts and protect both the landlord and the tenant.
Leases lay out important terms like rent amount, how rent will be paid, length of lease, and who is responsible for building maintenance. These terms can involve large amounts of money and should never be left up to an oral agreement that cannot be proved or enforced.
Image via Pexels by Artem
How To Lease Commercial Property
Leasing a commercial property and becoming a landlord may sound like a daunting task, but the process is relatively straightforward and is dependent on the type of space you will be renting – retail, office, or industrial. Most properties are priced on a per square foot basis and it is easy to find comparable properties online to get a sense of where the market is on pricing. Below are the steps to take to rent a commercial property:
- Determine how much space is available. Measure the property’s dimensions and multiply the length by width of the space available. Professional surveyors can also be used to determine the square footage of a property.
- Calculate a price per square foot. Use the square foot calculation from step 1 and divide that by your target monthly rent (monthly rent / square footage). Compare this number to comparable property listings for rent in your area.
- Market the property. Listing your property can be done online through a multitude of commercial lease websites. Hiring a broker is also a good option as they are professionals when it comes to marketing and renting commercial real estate.
- Negotiate the lease terms with your tenant. Once there is an interested tenant, start negotiating lease terms. This will include pricing, length of rent, who pays for operating costs, what the property will be used for, and other key lease terms outlined above.
- Run a credit check and background check. Chances are you are dealing with a small business or individual, and you will want to run a background check and credit report to make sure you do your due diligence on your future tenants. There are many companies that can assist with these items and will provide you with full reports that may highlight any red flags that you want to screen for.
- Approve or reject the tenant. Once the background check and credit report check out, decide whether you want to move forward with the tenant. Providing written communication to the tenant is preferable so it can be documented.
- Calculate a security deposit. Before a tenant moves in, you will want to collect a security deposit from the tenant so that you have cash in case anything goes wrong. It is common to ask for 2-3 months’ worth of rent as a landlord. These funds can help you if the tenant stops paying rent or the property requires repairs caused by the tenant.
- Draft a commercial lease agreement to use with tenants. Once you have approved the tenant and determined the high-level terms of the transaction, you will want to hire a real estate lawyer to draft a commercial lease agreement. The lawyer will be an expert at translating your terms into legalese and make sure you’re protected. You can find a commercial lease lawyer here or by posting a project on ContractsCounsel.
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How To Write a Commercial Lease Agreement
A commercial lease agreement is a legally binding contract. For the agreement to be legally binding, it will need to include all the essential elements that make a contract legally enforceable.
At a minimum, the lease agreement should include the property address, amount of rent, and duration of the lease with an effective start date. It should also include any other costs that the tenant and landlord will be responsible for. Leases need to be signed by both the landlord and the tenant.
You can find templates for commercial lease agreements online, but these will need to be tailored to fit the needs of the business and the property. If you have questions about drafting a commercial lease agreement, it is best to consult a real estate lawyer who will have knowledge about the laws and requirements for lease agreements in your state.
What Are a Commercial Landlords’ Responsibilities?
Responsibilities for commercial property landlords may be dependent on the type of lease terms they negotiate with their tenants. Below is a list of general responsibilities to consider:
- Checking property specs. The landlord will need to check and validate that the property can be used commercially for the activities that may be conducted by tenants. This may involve checking building codes and requirements for specific types of businesses.
- Decides how tenant use property. The landlord will need to decide how they want tenants to use their property and may have certain obligations. For example, if a business rents from a tenant, the landlord may not be allowed to rent property to a competitor.
- Setting lease terms. The landlord will need to create lease terms they offer to tenants. Terms will need to address the length of leases, who is paying for operating expenses, pricing, renewals, security deposits, and more. These terms should all be reflected in the commercial lease provided to a tenant.
- Tax obligations. The landlord will need to make sure property taxes are being paid. Taxes may be paid directly from the landlord or be the tenant’s responsibility, depending on the type of commercial lease put in place.
- Improvements & Repairs. The landlord may be responsible for making improvements to the building, should certain tenants require them. They will also need to address repairs, unless the lease terms they put in place makes it the tenants responsibility.
Types of Lease Lengths for Commercial Properties
Commercial properties can be leased in different ways and for different lengths of time. It is common to see commercial lease terms to last 5-10 years, but by no means is this a requirement. Leases can also auto-renew or convert into month-to-month arrangements. Below are the types of lease terms you see in the market:
- Fixed-Term. A fixed-term lease ends at a specific point in time. Lease terms cannot be changed during the term unless the commercial lease specifies that they can. It is common for a fixed-term lease to roll into a month-to-month lease.
- Periodic. A periodic lease automatically renews each year or each month, depending on what the lease arrangements are. Periodic leases provide flexibility since terms can be changed more frequently with proper notice to the client.
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Can a landlord increase the rent during the term of a commercial lease agreement?
I am a small business owner who recently signed a commercial lease agreement for a retail space. The lease specifies a fixed monthly rent for the duration of the lease term, which is three years. However, I have received a notice from the landlord stating that they intend to increase the rent by 20% starting from the second year of the lease. This sudden increase is unexpected and would significantly impact my business's profitability. I want to know if the landlord has the legal right to increase the rent during the term of the lease agreement, and if so, what options do I have to negotiate or challenge this increase?
Laura H.
One of the primary benefits of a lease, from a tenant's perspective, is that it allows them to stay in a property for a set time at a guaranteed rental rate. The landlord is bound by the amount agreed to in the lease and cannot legally raise it without the tenant's consent. They cannot force a tenant to consent by threatening eviction. Some commercial leases include a clause that requires the tenant to pay a portion of property taxes, utilities to the landlord, or other amounts that are not fixed at the time of signing. That could result in an increase before the lease ends. Read the document carefully to see if it has such a clause.
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