Understanding Commercial Real Estate Leases
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Understanding Commercial Real Estate Leases

When you list 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 must be read in its entirety before proceeding.

Leases are the basis of property performance. The best sellers 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 rules and basics that will allow you to 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 must read the document.

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After many years of working in the industry, I have seen the best people build the foundation for success around the leasing process. This means that they have grounded themselves with investment skills and knowledge by leasing properties for a few years. So now let’s look at how you can move forward on this leasing skill-building path.

The better you negotiate and the more fully you 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 premises; it is a tactical cash flow that can attract or detract from property value.

How leases work for the real estate investor will have a strong impact on the property and its performance over the life of the lease. As you work with tenants or buyers of the property, the type of lease that applies will also impact negotiations. Let’s look at the main types of leases and discuss some of the topics that are most relevant to you.

Gross Lease:

Under a gross lease, the tenant pays full rent that includes an expense component and the building owner will pay all operating costs of the building (also known as expenses). This means that the lease itself will have rent review provisions that will only increase the gross rent.

In such a lease, the landlord should know that he can keep building expenses at predictable levels over the term of the lease, since the landlord bears all the risk of paying the expenses. The levels of rent review increases in the lease must be expected to meet or exceed increases in the level of expenses in future years, otherwise the landlord will lose money.

Gross rents are common on commercial and office properties. Your choice to use this type of rental and lease must be balanced against the anticipated levels of outgoing costs and future changes for the subject property.

Obviously, an older building will have steady increases in expenses over and above that of a younger building. As a building ages and deteriorates, the gross leasing method becomes less attractive and more risky for the landlord.

Semi-gross lease:

In this type of lease, the lessor initially establishes a gross rent that is paid by the lessee and is revised during the term of the lease; however, the landlord is also paid some regular money for expenses that increase based on a specific calculation. This is how you do it:

The landlord specifically recovers increased expenses above a designated expense base year. This base year is selected at the commencement of the lease and is typically the last outgoing year reconciled prior to the commencement of the lease, which is typically the fiscal year prior to the commencement of the lease (because it is fully reconciled and is known as a fixed value ) .

As the new semi-gross lease progresses through its term, the lessee must pay escalating charges above the designated base year. For example, if in a lease the base year for expense purposes was stated as financial year 08/09 and the known level of expenses for that year was $85m2 per year, then in financial year 09/10 when the expenses increase to $97 m2, the tenant will have to pay expenses of $12m2pa. As the lease expires and in fiscal year 12/13, the expenses could be $108 m2, in which case the tenant will have to pay $23 m2.

In this type of lease, the base year is established and the outgoing “gap” is likely to increase significantly as the lease gets older. This type of lease is good for the landlord with younger properties as it protects against escalating expenses above the base year and still allows you to use a gross rent as a basis for charging and collecting rent.

It is common in this type of lease that the base year of the expenses is updated at the time of any revision of the market rent during the lease. Market reviews on this type of lease would be carried out 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 any particular point in a lease as the matter is negotiable at the beginning of the lease, however please be aware of resetting the basis for expenses and the impact it will have on the landlord.

As a further 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 ‘lease-savvy tenants’, such as the government or large corporations, to designate the type of expenses to which base year increases will apply.

Naturally, it is better for the landlord to recoup the increase in all expenses on a building above the base year, however, government and corporate tenants are well known for limiting the calculation to rate and tax increases.

Clearly, a lease is the product of negotiation, but you need to understand what can be done and then get the best possible lease for your client.

Net Leases:

The term net lease is mostly generic; therefore, you should be aware that there are 3 types of net leases within the category. So let’s take a look at them.

Net lease: In this lease, the lessee pays part or all of the property or local fees and taxes.

Net-Net Lease: In this lease, the lessee pays fees and taxes as stated in the ‘net lease’ method, but then also pays property and premises insurance premiums.

Net-net-net lease: In this lease, the lessee will pay the fees and taxes, the premises insurance, and then also pay the repair and maintenance costs associated with the premises.

So what type of lease is best for the owner? In most cases the Net-Net-Net Lease is the way to go, however it comes down to 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 owner and better rent review provisions that compensate for lower expense recovery for the owner.

Net net rents are common on properties that are fully occupied by one tenant. 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 toward some method of rent revision, and then the tenant also pays additional rent that is calculated from their billing or sales. As the tenant improves his trade, the rent increases.

An essential part of this lease structure is forcing the lessee to provide you with accurate and regular audited billing figures. The lease must support and enforce the audit process for the landlord. Monthly billing figures are the best way to go, as the tenant provides the audited figures to the landlord by, say, the 7th of the following month. The landlord then collects the rotation rent from the tenant based on the audited figures.

This type of lease is also observed in the new shopping centers since the new tenants stabilize the levels of clientele and sales, in supermarkets for the same reasons, and in hotels or motels. The basic strategy with rotating rent is to give the landlord some cash flow from establishing a base rent from the start of the lease, and then collect additional rent as ownership and leasing become more successful. in generating sales and customers.

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In all leases, the recovery of rent and expenses must be clearly stated 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 landlord’s future. It will also have an impact on any sales situation.

It pays to know what’s happening in the market regarding lease and rental types so you can make lease deals that are similar to or better than the rest of the market. The correct lease structure, document and rent will help sell properties at better prices.

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