A commercial lease is a legally binding agreement made between a landlord and a business tenant.
While agreements may be negotiated by reps on the landlord or tenant side (or both), ultimately, it is the owner/landlord who signs as the lessee, and the tenant who signs as the lessor.
A lease agreement essentially grants a tenant a specific set of rights related to a building, much aside from just being able to occupy space in that building.
The biggest determinant of those rights will usually be the type of lease being agreed upon by the tenant and landlord.
For property owners and businesses, the benefits of different lease types can actually vary quite a bit, all depending on the business type, location, and intentions of the owner.
Here, we look at the different commercial lease types and the typical terms that comes with an agreement.
Types of Commercial Leases
1. Single Net Lease
A net lease is perhaps the most common form of commercial lease agreement.
With a net lease, the tenant is responsible for a base rent payment, plus additional expenses associated with the property.
That might include one or multiple additional expenses, including:
- Property/building maintenance
This is sort of like renting a single-family home: the owner pays the mortgage, but the tenant pays the owner rent and is then responsible for paying for their own utilities, arranging maintenance, and so on.
But net leases come in many forms, with varying layers of responsibility for the tenant.
A single net lease, sometimes referred to as an “N” lease, is the simplest form of net lease.
With a single net structure, the tenant pays the rent and the property tax associated with the space they are renting.
Single net leases are one of the lesser common lease structures in commercial real estate.
One of the only reasons a landlord would use a single net lease, instead of a gross lease, is to ensure property taxes are paid on time.
With a single net lease, the landlord collects funds used to pay property taxes and then they can pay the taxes to the city directly.
2. Double Net Lease
A double net lease, or “NN” lease, makes the renter responsible for the base rent, property taxes, and the cost of building insurance.
With this type of agreement, the landlord maintains responsibility for utilities, maintenance and other related costs. Double net leases are often used in multi-tenant buildings.
This way, the landlord incurs the costs of structural issues on behalf of all tenants. The landlord will generally prorate property taxes and building insurance to each tenant based upon their total leased square footage.
3. Triple Net Lease
Arguably the favorite among commercial landlords, the triple net lease, or “NNN” lease makes the tenant responsible for the majority of costs, including the base rent, property taxes, insurance, utilities and maintenance.
This even includes standard property repairs associated with the commercial space in question.
For example, if the roof leaks, the tenant in a NNN lease will have to pay for it to be repaired. Given the costs born by the tenant in a NNN lease, the base rent payment is typically lower on a per square foot basis.
NNN leased properties are often owned by investors who prefer to take a more hands-off approach to management.
4. Bondable Net Lease
A bondable net lease is a variation of the NNN lease, one that places every imaginable risk related to the property on the tenant.
For instance, if the property were to catch fire due to an electrical issue, the tenant would be responsible for the rebuilding effort and would have to continue paying rent to the landlord in the meantime.
Bondable net leases cannot be terminated before the expiration date for any reason. Some landlords use bondable net leases to protect themselves from tenants seeking rent concessions in the event of major structural repairs required under a NNN lease.
5. Full Service Gross Lease
A full service gross lease is one in which the tenant pays a fixed rent each month. The landlord is responsible for covering all other costs, including those related to operations and maintenance.
O&M costs typically include insurance, utilities, management, and state and local taxes. Consider the full service gross lease similar to an all-inclusive resort—pay one flat fee and the rest of the amenities are included.
6. Modified Gross Lease
A modified gross lease is similar to a full service gross lease with one major exception—this lease type makes the tenant responsible for any incremental increase in the building owner’s operational costs beyond the costs calculated in the base year of the lease.
So, if the city increases property taxes, the tenant may be expected to pay a portion of the increase.
7. Percentage Lease
A percentage lease is a type of commercial lease that is most often used by restaurants and retailers.
With a percentage lease, the tenant is expected to pay a base rent – or a minimum amount of rent – in addition to a percentage of the business’s gross income. Therefore, the rent payment is calculated as:
Base Rent + % of Gross Profits = Rent Payment
The percentage must be agreed upon by both parties in advance.
Percentage leases are often calculated using what’s called a “natural breakpoint.” With this type of commercial lease, a natural breakpoint is calculated by dividing the base rent by an agreed percentage.
The percentage rent payable by the tenant is then calculated by dividing the percentage by the annual base rent.
Here’s an example of a percentage lease in action…
The owner of a shopping center signs a percentage lease with a nationally-branded furniture store. The furniture store is the anchor of the shopping center. The furniture store pays an annual base rent of $500,000.
They agree that the tenant will pay percentage rent equal to 5% over the natural breakpoint, in this case: $500,000 / 5%.
This comes out to $10,000,000. If the furniture store has gross sales, for example, of $12,500,000 one year, then the furniture store would pay an additional $125,000 in rent that year.
We arrive at this number by taking the amount in excess of the natural breakpoint – or $2,500,000 – and multiplying it by 5%, which equals $125,000.
There are other ways to set percentage leases. For instance, a landlord may agree to set rent solely as a percentage of gross sales.
This practice is more common when using short-term leases or when signing a commercial lease with a startup business that cannot guarantee a certain level of sales initially.
It may also be used when a company has had a few hard years (say, due to a recession) and expects business to pick up significantly in the years to come.
In that scenario, the business may not be able to pay a high base rent, but may be able to offer a higher percentage sales as business increases.
Typical Commercial Lease Terms
Commercial leases can vary quite a bit in length.
Some leases run month-to-month, which is particularly true when dealing with smaller commercial properties. Others have lease terms for 30+ years.
It really depends on the nature of the property, size of the business, and how long the business has been in operation.
That said, commercial leases generally take one of the following forms:
Fixed End Date
A lease with a fixed end date gives each party certainty around when the tenancy will end.
All terms of the lease remain the same during this period, and neither party must give the other notice before terminating the lease. The lease simply ends at the end of that period.
Some leases are structured to automatically renew after a certain period, unless either party gives advanced notice to the other.
For instance, the owner of a hair salon might sign a yearly lease with an automatic renewal on January 1 each year.
The terms of the lease remain in effect (including rent payment), unless the lease is renegotiated.
Somewhere between a fixed-end date lease and an automatically renewing lease is a lease option.
In this type of commercial lease agreement, the tenant agrees to occupy the premises for a fixed period.
At the end of this period, the tenant is given the option to extend their lease for a specific duration at already agreed upon terms.
For instance, a software engineering company might sign a 5-year lease for space in an office building with an option to renew their lease for an additional 5 years once their initial lease expires.
The landlord will typically include a rent escalator so that, if the software company agrees to renew their lease, the landlord will benefit from an increased rent payment.
This creates predictability and flexibility for both parties.
Analyzing and Understanding Commercial Tenants with Property Intelligence
The lease type on a commercial property can also tell you a bit about the intentions of the tenant.
With Reonomy property intelligence, you can identify the tenants in commercial buildings by type or name, then access contact information of property owners.
Property intelligence allows you to quickly find tenants, space, or both.
When analyzing an individual property, you can see a list of active tenants in a property, along with some contact information of the individuals associated with the business, and the contact information for the owners of the property.
For a bit more context, you can check out the video below or read about Reonomy tenant data.
Whatever the case may be, and whichever lease type a commercial tenant is currently locked into, it can be extremely helpful to understand everything about the commercial leasing process and those involved.