What You Need to Know Before You Lease Commercial Property for Your Small Business
Renting space for your small business involves more than finding the perfect location at a price you can afford. Why? You’ll also need to sign a lease, a complex document that typically favors the landlord—and your success can hinge on its provisions.
But the terms of a lease are usually flexible, and with a little know-how, you can negotiate terms that work for both yourself and landlord.
Things to Know Before You Negotiate Your Commercial Property Lease - These are key areas to consider before you sign on the dotted line:
Most commercial leases are quoted on a Rentable Square Foot (RSF) basis. This includes the square footage of your private premises, or Usable Square Footage (USF), plus a pro rata share of the building’s common areas (if shared with other tenants) such as lobbies, staircases, corridors and restrooms. RSF versus USF space is an important distinction to understand, as there will be a difference between the square footage you actually use and the square footage for which you are charged.
When evaluating different properties, measure the USF for yourself or ask the landlord for the dimensions. This will allow you to accurately determine and compare the size and costs of the premises your business will potentially occupy.
Commercial leases generally fall into one of three major categories based on how the building’s operating expenses are passed on to tenants:
- Gross or full-service lease. You pay a flat monthly rate from which the landlord pays all operating expenses, including utilities, property taxes and maintenance. This is a simple and convenient option for tenants. Just make sure you understand the extent of expenses included with the lease. For instance, are cleaning services provided? Is heating and air conditioning available 24/7? Is there a limit on electricity use, and if so, how will you be charged for excess? All such terms should be spelled out in the lease, so there are no surprises down the road.
- Net lease. In a net lease, taxes, insurance and building maintenance are shared between the landlord and the tenants in one of three ways. With a single net lease, you will pay monthly rent as well as the property taxes, while the landlord pays the rest. With a double net lease, you will pay for insurance along with the taxes and rent. With a triple net lease, you will pay for taxes, insurance and building maintenance costs in addition to the base rent. If you share the building with other tenants, the expenses you assume are pro-rated based on your share of the building’s square footage.
- Modified gross lease. This type of lease is a cross between a net lease and a gross lease. Usually, you will have a gross lease but will be responsible for certain agreed-upon expenses, such as cleaning services, electricity or minor repairs. The landlord will assume payment for the rest.
Before signing a lease, be sure you understand the type of lease, who will pay for what, and the potential extent of the costs you agree to assume. Ask to see examples of the expenses you will be expected to pay, and negotiate caps to minimize unexpected expenditures.
Most landlords prefer long-term leases of five to ten years, or longer, to keep vacancies to a minimum. You may get the best deal with a long-term lease, but it can become a costly liability if you go out of business or outgrow the space before the term is up. A one-to-two year lease with an option to renew offers the flexibility your small businesses may need—until you’re confident of its success and stability.
Try to work out a cap on any increases in rent that the landlord may expect, whether annually or upon the renewal of your lease, in order to keep the space affordable.
If you need to terminate your lease for any reason, ask to include provisions that allow you to do so as painlessly as possible, including:
- The right to transfer or “assign” your lease if you sell your business. This allows your business’s new owner to stay in the same space.
- The ability to sublet all or a portion of your space if you are unable to afford the rent or need to move to a larger space.
Also, consider negotiating any penalties in advance should you need to terminate the lease before the term is up.
Nearby tenants can have a significant impact on your business, and can be terms for negotiation. If your business depends on a nearby business to bring foot traffic, a co-tenancy clause will allow you to break the lease if that tenant leaves and isn’t replaced within a certain amount of time.
And if you’d rather not have your landlord rent nearby space to a business that competes with yours, ask for an exclusive use clause.
If you need to alter the space to suit the needs of your business, negotiate inclusion of “build-out” provisions in the lease that specify:
- The improvements that will be made
- Which party will pay for the improvements (in longer-term leases, the landlord may pick up the cost)
- Who will own the improvements (normally, the landlord does)
- If the tenant (you) will need to return the space to its original condition when the lease expires
A real estate broker can help you find commercial property and work through the complexities of a lease. Keep in mind, though, that the landlord normally pays the broker’s commission. This means that while there is no cost to you, you could benefit from the unbiased perspective of a lawyer experienced in commercial real estate.
A commercial lease is a legal, binding document. By understanding the terms and evaluating them carefully, you’ll be prepared to negotiate an agreement that not only meets your office space needs but protects your business interests over time.