Quick Commercial Lease Terms and Definitions
A more detailed analysis can be found in an early blog post.
Note: Many commercial real estate leases refer to the Tenant as the Lessee, and the Landlord as the Lessor, which is correct as the terms are synonymous. We will use the terms landlord and tenant to discuss these terms since those terms are less easily confused. The world of commercial real estate leases is complicated enough without confusing terms unnecessarily!
ALSO, different areas of the country use different terms and have different ways of doing things. For our purposes, we are using the most basic, typical examples.
There are three main types of commercial real estate leases: Full Service Lease, Gross Lease and Net Net Net Lease (also referred to as “triple net lease”).
FULL SERVICE LEASE: Used most commonly in high-rise, multi-tenant office buildings, a full‑service lease simply means all the services are included in the rent: operating expenses including maintenance, property taxes and insurance, security and janitorial services, as well as utilities such as water, electricity, heat and air.
GROSS LEASE: This type of commercial real estate lease says the Tenant pays a gross amount for rent (plus sales tax where applicable), and the Landlord is responsible to pay the property’s operating expenses such as property taxes, insurance, management or maintenance costs.
NET LEASE: the “Net Net Net” Lease directs the Tenant to pay the Landlord a “Base Rent” which is “net” of property expenses. Added to this is an additional amount for the Tenant’s share of the property’s expenses such as property taxes, insurance, common area maintenance (C.A.M.), property management, etc. Many times this is referred to as a “Triple Net” lease.
RENTAL RATE: Based on the “Rentable” square footage (after the “Loss Factor” has been added in), or the “Useable” square footage.
YEARLY RENT ADJUSTMENTS: Rent may be fixed over the term of the lease, or it may include yearly increases, or “adjustments”. Rent can either be adjusted by a specified dollar amount, a fixed percentage, or tied to a fixed index such as the Consumer Price Index (CPI).
TERM: “Term” is the length of the Lease, plus options to renew.
TENANT BUILD‑OUT ALLOWANCE: Commonly referred to as “Tenant Improvement Allowance”, T.I. Allowance, or simply “TI”, this is the amount of funding the Landlord will give to the Tenant to reimburse the Tenant’s cost of finishing the interior improvements.
PERSONAL GUARANTEE: Landlords may require that an individual(s) personally guarantee the lease, since most commercial real estate leases are between two business entities (LLCs, Corporations, etc.).
RENEWAL OPTIONS: Renewal options are a pre-negotiated agreement of the terms wherein a Tenant may extend his lease for an additional period.
NOTIFICATION: Usually there is a notification period prior to lease expiration in which the Tenant must notify the Landlord if it intends to exercise the option.
PERCENTAGE RENT: Also known as “overage rent”, percentage rent is when a percentage of Gross Income is also paid as rent.
BREAKPOINT: Used in Percentage Rent, the breakpoint is either a fixed number or it will adjust with increases in base rent. A “natural” breakpoint occurs when the Tenant pays its base rent or “x” percent of sales (whichever is more.)
NON-COMPETE CLAUSE: In relation to a commercial real estate lease, this is when a landlord may require a non-compete clause that will insure the Tenant will not open a similar store within a certain distance or market area.
USE CLAUSE: This clause specifies to what purpose the premises may be used.
EXCLUSIVITY CLAUSE: This provides the Tenant with an exclusive right to sell its product or service on the property
ASSIGNMENT : A Lease Assignment refers to all of the Tenant’s rights, title, and interest in the lease being assigned to another party.
SUBLETTING: Subletting occurs when the Tenant leases the premises to another but still has the primary responsibility to the Landlord to see that the terms and conditions of the lease are carried out in accordance with the original lease.
NOVATION: In both cases above, the Tenant is still “on the hook” with the Landlord, unless the Tenant has received a release of obligation from the Landlord (called novation.)
DESCRIPTION OF PREMISES: Useable square footage versus rentable square footage. A good commercial real estate lease will describe the location in the center, the size of the space and the method used to measure the space so that disputes won’t arise at a later date.
RELOCATION: In some commercial leases, especially shopping center leases, the Landlord has the right to relocate the Tenant to another space if the Landlord wishes.
LEASE‑OPTION : Occurs when the Landlord provides the Tenant with an option to purchase the premises.
DEFAULT: There are various ways for a Tenant to be in default of its Commercial Lease, such as non-payment of rent, selling goods or services not included in the use provision or not operating during the agreed upon hours.
REMEDIES OF DEFAULT: The Landlord will typically want the freedom to use every possible remedy to cure a default and all possible power to remove the Tenant from the premises should that become necessary.
ESTOPPEL LETTER: A letter from Tenant that will acknowledge the Tenant’s current lease situation. Typically this “Estoppel Letter” will note the remaining term on the existing lease, rental amount and any existing arrears or outstanding charges.
INSURANCE: The Tenant must obtain its own liability insurance and insurance for the contents of the space, including inventory and tenant improvements. The Landlord may specify the specific dollar amount of liability coverage required by the Tenant. The Landlord will also insure the building in respects to liability and property damage (and may pass that cost on to Tenant). While both parties liability coverage may overlap, the property insurance covered by the Landlord includes everything except the interior contents of the Tenant’s space. Most commercial leases require the Tenant to provide the Landlord with proof of insurance.
TAXES: Any good commercial real estate lease will be clear on which party is responsible for paying any taxes levied on the premises. In a net lease the Tenant pays. Even with a gross lease, any increases may be passed on to the Tenant. There also may be a provision for special assessments for sewer, road, street lighting, etc..
DAMAGE OR DESTRUCTION: A good commercial lease should note what happens if a natural disaster impacts the property (i.e. does the Tenant continue to pay rent and for how long.) This clause covers that situation and gives both Landlords and Tenant the options of how much time is allowed for the Landlord to repair the premises, and what are the Tenant’s obligations.
REPAIRS: Who makes repairs to the premises (electrical, plumbing, HVAC, etc.) ? Obviously, it would be ideal for the Landlord to make all exterior and interior repairs but this is usually not the case.
ALTERATIONS: Addresses the changes a Tenant can make to the premises, and the permissions Landlord must give prior to work commencing.
CONDEMNATION: This lease clause discusses in detail the possibility of the city, county, state or federal governments condemning all or part of the property for a road, right-of-way, or utility easement. Usually the Landlord’s responsibilities depend on the amount of the property condemned and the effect on the parking area and physical building.
ATTORNMENT: If foreclosure proceedings are brought against the Landlord by the mortgage holder (or if a deed is given in lieu of foreclosure), the Tenant shall recognize the transfer and accept the new owner as the Landlord.
SUBORDINATION: When a buyer purchases the building the Leases remain in place and are not affected by the change in ownership, i.e. Tenant agrees that the Lease is subordinate to the mortgage.
NON-DISTURBANCE: In the event of foreclosure, the lender has the option of keeping or terminating the lease. Many times this term is not in the lease!
HOLD OVER: This lease clause specifies the situation if the Tenant stays beyond the term of the lease. Usually it states what conditions and terms of the lease will apply, as well as any increase in rent during this hold over period.
INDEMNIFICATION: Very standard in any commercial real estate lease, Tenant agrees not to file suit against the Landlord for any mishaps that occur at the premises (i.e. bodily injuries sustained by Tenant or customer.) It usually also states that if the Landlord and the Tenant are named in a lawsuit together (perhaps a customer is filing a lawsuit) then the Tenant shall pay all the Landlord’s costs in connection with such litigation.
APPOINTMENT OF A RECEIVER: Specifies what happens if either the Tenant or the Landlord declare bankruptcy, as well as any actions a receiver may take.
ABANDONMENT: Discusses Landlord’s rights if Tenant abandons the premises during the lease term.
RULES & REGULATIONS: This covers items such as parking regulations, sign requirements, limitations on noise and smell, etc. Landlord usually has the right to modify the Rules and Regulations as changes become necessary.
NOTICES: This section covers how the Landlord and the Tenant deliver any notices and what constitutes a receipt of notice.
RECORDING THE LEASE: In some regions the Landlord will record the entire lease or a short form of the lease in the county governmental offices. A recorded lease is considered to be an encumbrance on the property. In some states a lease for a period over 10 years must be recorded and, for state transfer tax reasons, is considered a sale and taxed as such.
We hope you have found these commercial lease terms and definitions useful. There is still no substitute to having an experienced commercial broker negotiate the financial terms, and a real estate attorney review the lease prior to signing.