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Negotiating a commercial real estate lease is one of the most important skills that a real estate investor and real estate operator can possess. Whether you are an experienced real estate professional, or this is your first real estate property, understanding how to navigate these negotiations can significantly impact the profitability and operational efficiency of your real estate investment. From retail to multifamily and industrial to office properties, this guide will teach you the practical steps necessary to negotiate a commercial lease.
Before focusing on negotiating a real estate lease, it’s important to understand the basics of commercial real estate leases. In contrast to a lease for a single family rental, a commercial property lease could house multiple tenants (e.g., a multifamily property) or multiple companies (e.g., retail property). The terms of commercial leases typically are more complex and negotiated than the traditional residential lease agreement.
Here are some key types of commercial real estate leases:
In a gross lease, the landlord covers all property-related expenses, which include taxes, insurance, and maintenance costs. The tenant pays a single, flat rent. Tenants may prefer a gross lease because they have predictable monthly expenses, but they don’t have to worry about additional expenses.
In a net lease, the tenant is responsible for the base rent, but also the tenant pays some or all of the property expenses. These expenses could include, for example, property taxes, insurance premiums, and maintenance.
There are several types of Net Lease, including:
A percentage lease involves the tenant paying a base rent plus a percentage of their monthly revenue, and is typically used in retail stores such as in a shopping center or mall. The percentage rate is negotiated between the landlord and tenant and is intended to align both parties’ interests based on the success of the underlying business.
A modified gross lease splits some of the financial responsibilities between the landlord and the tenant. For example, the tenant pays base rent, and the landlord and tenant share costs for taxes, insurance, and maintenance. Landlords and tenants can customize and negotiate the lease terms, so this structure is a hybrid between a gross and net leases.
In an absolute net lease, the tenant is responsible for property expenses, including the building’s roof and structure, which are typically the landlord’s responsibility in a standard triple net lease.
A ground lease allows the tenant to lease the land only and construct a building on the property. At the end of the lease term, ownership of the land and all improvements typically revert to the landlord.
First, it is paramount to understand the local market conditions. What are the existing rent prices and how is rent expected to grow? You should understand vacancy rates, evaluate comparable properties, and assess average lease terms. If you decide to include future rent increases, one option is to tie increases to an independent economic index such as the Consumer Price Index (CPI) or include them as a fixed percentage.
The length of the lease can significantly impact your investment. While a multifamily lease is short term such as one year, a retail tenant could sign a 20-year lease. The advantage of longer duration leases is that it provides steady cash flow and stability to tenants. The disadvantage of a longer lease is that they lack flexibility to make modifications due to changing market conditions.
It’s critical for landlords and tenants to determine in advance who is financially responsible for maintenance and repairs. If a landlord passes on these costs to the tenant, the parties may consider negotiating caps or limits on the costs so that they are reasonable.
While tenants may want flexibility to sublease, landlords may want to limit subleasing to reduce tenant risk. The parties should define in advance the circumstances under which subleasing is permitted, and consider what the tenant’s rights are to approve any subtenants.
Both parties may want a right to terminate the lease. If the tenant and landlord both agree to this flexibility, negotiations should define the conditions under which a lease can be terminated, whether it’s for cause or no cause, and if there are any monetary penalties for termination.
To succeed in commercial real estate negotiations, know every aspect of lease agreements, including lease types, key provisions, and lease structure. You should assess your local market conditions and focus on comparables to determine if your proposed lease is reasonable in the current environment. Clearly define all terms and consider all scenarios to reduce future conflicts. With these strategies, you can have a successful commercial lease negotiation.
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