Types of Commercial Real Estate Leases and Clauses

There are many forms of commercial real estate leases, due to the fact that there is not a universal lease template or standard at any state or national level.  Unless you are dealing with the same landlord on the same property, the odds of someone seeing a lease agreement that is even relatively similar to a prior lease agreement is very rare. For example, in terms of the length of a lease document, you may see a lease agreement that is 15 pages long on one property and a similar property nearby with a different owner could present a lease that is 85 pages long. You might think a 15-page lease agreement is better because you can read it faster, but it could be missing many key deal points that are meant to protect the tenant as well.

Simply put, there is no standard or perfect lease length and nearly every lease agreement will be heavily drafted in favor of the landlord. Since evaluating leases can be daunting even for seasoned professionals who have had multiple leases and locations, the best thing you can do to prepare yourself is to understand the different types of lease structures along with the benefits and obligations that accompany them.

To put this in perspective, in residential real estate, most states have an industry recognized template for purchase contracts that nearly every agent or broker uses when buying or selling real estate in that state.   Since this is clearly not the case for commercial real estate, it is vitally important that you understand the terminology and variations in lease structures so you can be better equipped to choose the right property for your office space as well as the right terms.

First and foremost, you should always hire a qualified real estate attorney to represent you in any lease or purchase review. If you are signing a legally binding document that is drafted by an opposing party, it needs to be properly reviewed.

Prior to agreeing on terms for a deal and moving forward to a draft lease, it’s important to understand the different types of lease structures and clauses. Those clauses affect how much you are going to pay in rent and what other obligations or expenses get charged to you in the future. Understanding this will help you properly evaluate all your options so you can confidently move forward with one space in particular.

The following lease structures and clauses are some of the most common you will encounter in the commercial real estate market.

 

WHAT IS A NNN LEASE / TRIPLE NET LEASE?

A Triple Net Lease or NNN Lease is one of the most common lease structures in Commercial Real Estate. In addition to the tenant’s base rent, a Triple Net Lease contains a provision for the tenant to pay certain costs associated with operating the property. Those costs are outlined in three “Nets”.

Each “N” or “Net” stands for: property taxes, property insurance and operating expenses.

Operating Expenses are often also referred to as CAM – Common Area Maintenance and are the expenses it takes to run the property. Those expenses include repairs and maintenance, trash removal, snow removal, landscaping, parking lot maintenance, property management, exterior lighting and more.

Depending on the property, utilities and janitorial may also be included in the Operating Expenses or CAM. With a Triple Net Lease, you typically pay the landlord one check per month, but that check is broken down into two main categories:

  1. The Base Rent Amount
  2. The Triple Net Amount (or NNN)

For example, if you leased a 2,000 SF space with a $24 per SF Base Rent and $8 per SF Triple Net, the breakdown of payments would be:

  • Base Rent: 2,000 SF x $24 per SF = $48,000 per year or $4,000 per month
  • Triple Net: 2,000 SF x $8 per SF = $16,000 per year or $1,333 per month

Total rent would be $5,333 per month; with the Triple Net being $1,333 per month.

Triple Net leases are the most common type of lease you will find in Retail Properties, newer Medical Buildings and the majority of Office Buildings. The next most common lease is a Full Service Lease, followed by Gross Leases and Modified Gross Leases.

In most states, the rent is calculated on a per square foot per year cost. However, states like California charge rent on a per square foot per month cost. So $24 per SF per year in Florida is the equivalent of $2 per SF per month in California.

WHAT IS A FULL SERVICE LEASE?

A Full Service Lease is typically defined as a lease that has one, all-inclusive rental rate that includes both the base lease rate and the operating expenses (property taxes, insurance and common area maintenance) combined into one number for the first year’s lease rate.

For example, if you leased a 3,000 SF space with a $30 per SF Full Service Lease Rate, the breakdown of payments would be:

  • Full Service Lease Rate: 3,000 SF x $30 per SF = $90,000 per year or $7,500 per month
  • Or in California: 3,000 SF x 2.50 per SF = $7,500 per month

Included in the $7,500 per month amount is both the base lease rate and the operating expenses.

With a Full-Service Lease, the Tenant is generally still responsible for any increase in the operating expenses in year 2 of the lease and beyond. The increases are typically determined by whether the lease contains a “Base Year” or “Expense Stop”. An important aspect of a Full Service lease is to understand if the utilities and janitorial are included in the lease rate or if they are billed separately to the tenant, and how any increases in operating expenses will be “passed through” to the tenant.

Full Service Leases are typically found in Office Buildings. You can also find them in some industrial or warehouse properties.

WHAT IS A BASE YEAR? | WHAT IS AN EXPENSE STOP?

A Base Year clause is found in many Full-Service and Gross Leases. It is not found in triple net leases. The Base Year clause is a year that is tied to the actual amount of expenses for property taxes, insurance and operating expenses (sometimes called CAM) to run the property in a specified year. In a new lease, the Base Year clause is most often the year the lease is executed or the year in which the lease commences.

The actual amount of expenses that are tied to the Base Year (property taxes, insurance and operating expenses) becomes the baseline or ‘floor’. As the lease advances in years, the tenant is responsible for paying any increase above the Base Year amount.

For example, if a lease commenced in 2015, and the total rent was $30 per SF, with $10 per SF being the property taxes, insurance and operating expenses for the property, the Base Year would be 2015 and the Base Year amount would be $10 per SF.

If in 2016 the property taxes, insurance and operating expenses did not change or even went down, the tenant would not owe any additional payment. However, if in 2017, the property taxes, insurance and operating expenses increased to $10.25 per SF, the tenant would then be responsible for a one-time payment of $0.25 per SF ($10.25 minus the $10 per SF Base Year amount from 2015).

Once the landlord establishes that there will most likely be an increase above the Base Year amount in future years, many landlords will divide the anticipated or prior increase into a monthly amount and ask the tenant to pay it on a monthly basis with their regularly scheduled monthly rent check. This approach is also preferred by many tenants, as it prevents the tenant from getting surprised by an isolated bill or one-time expense they were not planning for. Paying the increase in the Base Year in future years on a monthly basis can help the tenant maintain a better budget.

Another term that is often used alongside or similar to Base Year, is Expense Stop. Essentially, the Base Year amount is synonymous with the Expense Stop amount, which is the actual amount of money that comprises the property taxes, insurance and operating expenses. Just like the Base Year amount, the tenant is responsible to pay any increase in those expenses above the Expense Stop amount.

If the Expense Stop amount in a lease is $10 per SF at the start of the lease, the Tenant will then pay any increase in the taxes, insurance and operating expenses that exceeds $10 per SF in year 2 and beyond in the lease.

 

WHAT IS AN ESCALATION CLAUSE OR ANNUAL INCREASE?

An Escalation Clause is often referred to as an Annual Increase Clause, an Annual Rent Increase or an Annual Rent Bump. An Annual Increase is a clause in a lease which provides for the base rent amount or operating expenses to be increased and/or to reflect changes in expenses paid by the landlord such as real estate taxes, insurance and operating expenses.

The Escalation Clause or Annual Increase may be accomplished by several means, including:

  • Fixed periodic increases such as 3% per year or $1.00 per SF per year
  • Increases tied to the Consumer Price Index
  • Or, adjustments based on changes in expenses actually paid by the landlord in relation to an Expense Stop or Base Year amount.

The majority of leases will have an Escalation Clause or Annual Increase tied to the Base Rent, Full Service Rent or Gross Rent. The majority of leases will also contain a clause that allows the landlord to collect an increase in the triple net or operating expenses as those costs increase beyond the first year of the lease.

Essentially, the Annual Increase is the amount of money the rent increases each year beyond year one of the lease.

Beyond what was covered in this article, there is always more to learn. There are additional types of leases such as Gross Leases and Modified Gross Leases, as well as dozens of additional lease terms.  This terminology is important to understand as you evaluate real estate opportunities for your practice.  Understanding each term will further equip you to make the most informed decision benefitting your practice.

Travis Smith | Agent | Missouri
Carr Healthcare Realty is the nation’s leading provider of commercial real estate services for healthcare tenants and buyers. Every year, thousands of healthcare practices trust Carr to achieve the most favorable terms on their lease and purchase negotiations. Carr’s team of experts assist with start-ups, lease renewals, expansions, relocations, additional offices, purchases, and practice transitions. Healthcare practices choose Carr to save them a substantial amount of time and money; while ensuring their interests are always first.
Visit www.carrhr.com to find an expert in your area to help with your commercial real estate needs.

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