I’m leasing a space for a new business; where do I start?
The first thing you need to do is to determine your needs:
- How much space do we need?
- How much rent can we afford to pay?
- When does my new space need to be ready?
- Have I taken into account everything that is needed in my new space (furniture, phones, computers, copy/fax/postage machines, Internet access, etc.)?
How are lease rates quoted for commercial property?
Typically, with commercial properties, lease rates are based on the annual cost, per square foot, of the leased space. To determine the monthly rent for a property, one would need to multiply the quoted rent per square foot by the number of square feet being leased. The resulting product is the annual rent for the leased premises. That number should then be divided by twelve to arrive at the monthly rent figure. One must then know whether the quoted rent is a gross rental rate, gross plus utilities or a triple net rate.
Example for Office (Retail and Industrial are NNN):
500 square feet x $10 per square foot = $5,000 annual rent.
$5,000 annual rent / 12 months per year = $416.67 rent per month.
Now that I’ve found a space, how long of a lease should I sign?
This can be one of the most difficult decisions you will need to make. There are a number of factors that come into play here (yes answers are more indicative of a longer lease term, while no answers indicate that short term lease flexibility is more important):
- Is my business stable such that I don’t expect my future space needs to change?
- Does the space that I am leasing require a substantial investment in tenant improvements?
- Do I expect rents to increase significantly in the future?
- Is the location of my new space very important to the success of my business?
- Is relocating my business hard to do/what are the moving costs?
- Is my rent lower if I sign for a longer term?
The first two items are the most important points to consider. If you have a start-up business, then a shorter lease term is most likely better. However, if your start-up business requires significant improvements, then you may be forced into a longer term lease by the simple economics of amortizing the improvements over a long term so that your base rent is affordable. Ask the question, “What is the difference in rate between a three year and a five year lease?” Once you have that answer, then decide.
What is the difference between usable square feet and rentable square feet?
Rentable Square Feet: Includes space allocated for common areas such as lobbies, stairwells, hallways, bathrooms and mechanical areas.
Usable Square Feet, “USF” is the actual measurement of the space that the tenant will occupy.
“Rentable Square Feet” RSF starts with the Usable Square feet and then the landlord adds a loss factor for hallways, elevators, stairways, lobby, mechanical rooms, etc and usually a profit factor. RSF is calculated differently by every landlord.
Landlords set the rent on the RSF, based on “Rentable Square Feet”, which includes a shared allocation of space for common areas such as lobbies, stairwells, hallways, bathrooms and mechanical areas. Most tenants are interested in “Usable Square Feet,” the actual measurement of the space that the tenant will occupy. Based on the landlord’s RSF measurement, one can expect a minimum loss factor of 18-25% for a full floor and 30-40% for a multi-tenanted floor.
I have heard the term ‘build-out’ what does mean?
Every business has its own jargon and the commercial real estate business is no exception. Many office and retail buildings start out with tenant spaces consisting of little more than four walls and a door. The idea is that the spaces will be finished to meet the specific needs of each tenant.
The process of finishing this raw space is known as the “build-out”, “fit out”, or “tenant improvements” (TI for short). There can be extensive negotiations between the building owner (landlord) and the tenant over:
- What improvements will be made?
- Who will pay for these improvements?
- Who will be in charge of getting the work done?
- What will the tenant be permitted (or required) to remove at the end of the lease?
I have heard the term ‘tenant improvements’ what does it mean?
Tenant improvements are the improvements or remodeling tasks that need to be completed before the tenant can use the leased premises as intended. This is naturally a moot issue if the space is move in ready, or can involve construction of an addition to a building or a significant structural change to the building.
The cost of tenant improvements is negotiable as are other portions of a lease agreement. Often, a property owner will offer a stated “build out” allowance with new construction property ranging from $10 to $30 per square foot to assist the tenant with build out expense.
What is the difference between a net lease and a gross lease?
Net and gross are different ways of quoting rent. A gross lease means that the stated rental rate includes the major expenses from real estate taxes, property insurance and common area maintenance, and that no additional rent for those items is required to be paid. In an absolute gross or full service lease, the quoted rate will include basic utilities such as electricity, gas, water and sewer. A triple net or NNN lease is one where the rent is quoted as a base rent net of, or not including, the expenses for real estate taxes, building insurance and Common Area Maintenance (CAM). These three expenses, as well as the utilities, are an extra charge over and above the base rent. Under a NNN lease, the tenant will also be responsible for utilities in addition to the NNN expenses. In between a gross rental and a NNN rental is a gross plus utilities rental where the quoted rent covers the taxes, insurance and maintenance expenses but does not include utility charges for the leased premises such as gas, electricity, sewer and water. Typically, a tenant will pay for its own telephone and internet services under any of these lease types.
What are CAM Charges?
CAM stands for common area maintenance and typically includes the costs of snow removal, lawn mowing, common utilities, janitorial services for common areas, etc. and are more common with single tenant, retail, and industrial leases. They are not very common with office leases. Landlords and tenants should be careful to note all the things that can be included in CAM charges and whether it can include things such as management fees, administrative costs, seasonal shopping center decorations, etc.
What is a typical amount for Triple Net (NNN) Charges?
The amount of NNN charges will vary depending on the type of property, its location, its size and how fastidious or frugal the property owner is in managing the property. In years of heavy snow fall, for example, the NNN charges will be higher. There may also be repairs or updates required for common areas that increase NNN charges. Real estate tax and insurance rate variations can also impact the amount of NNN charges. Essentially, a gross lease places the risk of increases in these expenses on the landlord while a NNN lease places the risk of increase in these costs on the tenant(s). In most situations, the landlord will estimate the total amount of the NNN expenses for the year and the tenants of the building will pay estimated monthly installments of the NNN expenses as additional rent during the year. At the end of the year, the actual expenses will be reconciled with the estimated expenses and the account will be trued up and any over-payments by the tenant will be credited to rent while any under-payments are to be paid within thirty days by the tenants. In a multi-tenant building, the tenants will pay these expenses proportionately in the same ratio that their square footage of space bears to the total square footage held out for rent in the building. In the event some of the space in the building is vacant, the property owner will generally have to bear that proportionate amount of the NNN expenses.
Are there standard representations and warranties usually included in a commercial contract?
No. Representations and warranties are always a matter for negotiation. There are many commercial real estate contracts that say, in effect: “The property is being sold ‘as is.’ Seller makes no representations or warranties.”
When a seller is making representations and warranties, the seller’s lawyer may insist on adding the cautionary words, ” . . . to the best of seller’s knowledge.” That way, the seller is not guaranteeing unknown facts or conditions.
If you are buying income-producing property, your lawyer may want the seller to guarantee the accuracy of the rental income figures as well as the expenses the seller has represented to you. You may also want the sales contract to include a statement that the seller is aware of no hidden defects in the building – that is, defects that your inspector is unlikely to discover.
How should I take legal title to commercial property?
You can, of course, take title in your own name. Typically, a buyer will form a corporation or limited liability company (LLC) and putting the legal title in the name of the business entity. This requires more paperwork and a bit more expense, but you limit your personal liability if someone gets hurt on your property.
By limiting personal liability, you decrease the risk that you could lose your other assets such as your home and personal bank accounts if there is a big verdict in favor of an injured person.
Your attorney will help you decide if putting your commercial real estate into a separate legal entity is the best thing for you to do.
What is a Tax Deferred or 1031 Exchange?
1031 exchanges are specifically structured transactions that join together the sale of an old property and the purchase of a new property for the purpose of deferring taxes. 1031 Exchanges are primarily used for buying and selling investment real estate, but they can also be used for personal property that is used in a business. Examples of qualifying property include bare land, rental property, commercial buildings and homes other than your primary residence. You should contact an attorney and your tax advisor on every tax exchange for specific advice. Check out the IRS website for more information on Like-Kind Exchanges.