Commercial Real Estate Leasing Process

Determine Your Leasing Requirements

The leasing process should begin with an assessment of your company's requirements for commercial real estate space. Hundreds of vacant spaces are likely available, some inside the city's major commercial corridors while others far removed, each with its own particular benefits and downsides. Putting together a list of your firm's essential needs can help you restrict your search and better inform any real estate specialists you choose to involve in this project.

As you consider your requirements, the following details merit particular attention before starting your search:

Zoning and Property Type

First, just eliminate spaces that can not accommodate your specific use case. If you're seeking a flex space with office, there's no need to investigate a commercial facility that's been converted into a restaurant. While it may seem obvious, the intended use of the space is critical information and prevents a lot of wasted effort for both you and your property team. It is also important to understand the zoning requirements and restrictions of municipalities being searched, particularly as they relate to your service or industry.

Location

Does your business rely on foot traffic? Retail adjacency? Traffic counts? Smaller businesses or those using warehouse space may have options further from the city core that meet these requirements and still remain affordable, while high-profile businesses should probably look to a city's premium commerce or financial districts where they receive maximum prestige and visibility.

Accessibility

A convenient location with adequate parking has always been an important consideration for firms where employees regularly conduct business in the office, however this takes on heightened importance in times of tightened labor supplies when businesses must compete for the strongest talent. Traffic considerations or satellite office locations could be the competitive difference when attempting to land employees. Likewise, if your customers are expected to walk into your business, parking or incidental foot traffic must be considered.

Employee Requirements and Perks

One of the main reasons companies seek new space is that they are in the process of or have already outgrown their existing space. This often happens with fast-growing startups. Most commercial office spaces should provide an average of 150 and 300 square feet of space per employee to keep staff from feeling squeezed together and unhappy in the workplace. Also, if you want to compete with the tech industry's employee-friendly heavy hitters, you'll want to give some thought to locations with amenities like gyms, cafeterias, and shared public areas, keeping an open dialogue with staff throughout the process to ensure that the new space meets their expectations going forward.

Maximum Monthly and Annual Budget

Last, but certainly not least, one must give due consideration to the overall cost of the lease, as that will almost always be the most important and significant aspect in your commercial real estate search. The most common metric for evaluating properties, cost per square foot, is widely used both to compare properties and to generate estimates of annual costs for specific properties.

Selecting a Commercial Broker

Brokers facilitate the vast majority of commercial real estate leases, representing either the landlord (leasing agent) or the tenant (tenant broker).

The owner of a commercial property hires a listing agent to market their vacant space. The owner, or landlord, agrees to pay a commission to the listing agent based on a percentage of the total dollar value of the entire lease. Tenant brokers, conversely, advocate for tenants’ concerns in the leasing process. The tenant broker’s fee is usually paid as a proportion of the total commission paid by the landlord.

This arrangement means that a listing agent is ethically bound to act in the interests of the property owner. While the tenant-broker represents the renter, he or she is not always obligated to operate as a fiduciary on behalf of the tenant. The tenant-broker’s role can occasionally be more akin to that of an objective third-party, as we shall explore in more detail below.

When to Use a Tenant Broker

A tenant is certainly not required to use a broker, however, they can be beneficial to the tenant in a number of ways. They provide detailed lists of available properties, comps, and pricing. They also have detailed knowledge of local market conditions and considerable experience with negotiating complex leases. Furthermore, because the landlord normally covers the tenant broker's charge, this value is usually provided at no additional charge to the tenant. As a result, it's usually in your best interest to have a tenant broker to assist you with finding suitable leasing locations. It is important, though, to carefully understand the terms of the brokerage agreement, as the language can vary considerably from one to the next.

Exclusive Brokerage Agreements

Brokerage agreements in which the tenant works with a specific broker and is restricted from working with any other tenant brokers, often for a period of three to twelve months, are considered exclusive agreements. A commission is negotiated between the tenant and the broker, however, it is only paid if there are no tenant broker fees paid by the landlord. This, of course, rarely occurs, effectively eliminating the commission split between the tenant and the broker. This is an excellent alternative for the tenant because it introduces a fiduciary obligation into the brokerage agreement.

Non-exclusive Brokerage Agreement

There are two principal forms of non-exclusive brokerage agreements: the “right to represent” and “not for compensation”. The right to represent non-exclusive agreement allows the tenant to work with other brokers, but still includes the commission language for the tenant broker. The not for compensation agreement provides maximum flexibility for the tenant, however, there are important considerations with respect to fiduciary duty once the commission requirements is removed.

Working Without a Broker

It should be stressed that working with a tenant broker is not a requirement. While a tenant broker can be beneficial, there is nevertheless a possibility that you will end up paying a commission.

There are publicly searchable sites for commercial real estate listings, such as LoopNet if you want to seek for commercial real estate properties on your own. Doing it on your own means you will also need to locate new listings, arrange walkthroughs, and negotiate leases, each of which are very much in the wheelhouse of the experienced tenant broker. Essentially, the sole advantage

The sole advantage of not utilizing a broker is that you won't have to, potentially, pay a commission.

Types of Commercial Leases

Although there are really just two different types of rent payment methods, gross or net, there are several key characteristics that tend to differentiate the different types of leases

Gross Lease

A full-service lease, or gross lease, is an option for tenants willing to pay a higher rent in exchange for an all-inclusive rent. The landlord in this scenario is liable for the majority of the expenses related to the property's operation, such as upkeep, insurance, and property taxes.

Some of these costs are, of course, determined by the terms of the lease agreement between the tenant and the landlord. For example, janitorial services could be included in the rent but limited in terms of frequency or type. Tenants that require daily rather than weekly cleaning, or perhaps that are over and above those considered normal for the market, will need to negotiate a rent that reflect this or that makes them liable for the expense.

Essentially, the landlord is responsible for paying for and maintaining the building in this arrangement, leaving the tenant responsible for paying rent and growing their business.

Modified Gross Lease

A modified gross lease is more frequent in multi-tenant buildings and tends to balance responsibilities between the landlord and tenant. The renter pays a single payment for rent and then other fees directly linked to their own unit, such as maintenance, repairs, and utilities, while the landlord covers other expenditures such as common area upkeep, landscaping, and lot care (often including insurance and property taxes as well). This sort of lease is commonly used in office buildings since it is more equitable for all tenants.

Net Lease

In a net lease, tenants agree to pay a cheaper rent in exchange for taking on part or all of the other "standard" expenses such utilities, cleaning services, taxes, and property insurance. Property tax, property insurance, and property maintenance are the three nets in net leases. These additional costs vary from agreement to agreement, and which costs a tenant bears is determined by the type of net lease signed.

There are three general types of net leases, each differing slightly in how costs are allocated between landlord and tenant. However, because commercial leases are so flexible, the parameters of who pays what might be unique to each arrangement, regardless of the parties' intent to construct a specific form of net lease.

Single Net Lease

The tenant pays rent plus one net cost: property tax under a single net lease. In this situation, the tenant is responsible for a percentage of the building's property tax based on the proportion of total building space being rented. Other building expenses are usually covered by the landlord, whereas utilities and janitorial services are usually paid by the tenant.

Double Net Lease

In a double net lease, the tenant typically pays base rent, a proportional share of building property tax (as in a single net lease), and property insurance (the second net). The landlord is responsible for structural repairs and maintenance in common areas such as lobbies and restrooms. In most cases, the tenant takes on responsibility for cleaning and utility expenses.

Triple Net Lease

The tenant, rather than the landlord, bears the majority of the responsibility in this sort of net lease. The tenant is accountable for some or all of the real estate ownership expenditures in addition to the base rent. Property insurance, property taxes, and property maintenance are all included in these fees. Utilities, maintenance, repairs, and operation costs are usually covered by the renter.

The landlord's responsibility in this arrangement is to supply space and charge the tenant for using that area to do business. The tenant is responsible for almost all other costs.

Identifying Commercial Properties

In addition to your property parameters, consider the following while evaluating commercial property listings:

Location

Make sure the property is in close proximity to your target consumer or staff. You'll also want to choose a location with enough pedestrian and vehicle traffic, as well as enough parking for customers or staff.

Amenities and Services

You should be aware of the complete spectrum of services provided by commercial space. Communal rooms, outdoor space, food options, free Wi-Fi, loading docks, sewage and utilities, on-site security, and other amenities and services may be available. These amenities and services may be dictated to some degree by the zoning classification for the property.

Landlord History

The lease agreement, revisions to the lease agreement, rental increases, and other terms will very certainly be dictated by the landlord you choose. The importance of this is underscored by the fact that business leases are often multi-year arrangements. Therefore, it is important to do your due diligence regarding both potential landlords and property management companies you will be engaged.

Anchor Tenants

An anchor tenant can be found in some multi-unit commercial developments. This tenant, like Wal-Mart, serves as the focal point of a mall or shopping center. If the anchor tenant vacates, the landlord may be able to legally terminate the remaining leases on the property, so it is important to be aware of these tenants and any related lease clauses.

Conduct Multiple Walkthroughs

You and your broker should consider a variety of commercial spaces. This provides you a better idea of the average pricing and gives you an advantage during the negotiation. You'll want to compare rents during your search to be sure you're staying within your budget. Before signing a lease, it's a good idea to check at least four to ten commercial buildings.

Walkthroughs, known as “technical property reviews”, are carried out with the help of your broker and the landlord's broker. After you've looked around the properties, consider the various lease agreements and the terms included in each.

You may also wish to have a professional contractor walk around the property with you. They can help evaluate potential lease build outs, which are required additions or modifications to the space. The landlord may bear all or part of the build-out costs, so it's imperative to receive an exact remodeling estimate and negotiate these costs as a build out in the lease.

Negotiating Lease Terms

When you're ready to start negotiating a commercial lease, you'll want to start by asking to see the terms in writing. This request might come from you or your broker, and the landlord's broker will fulfill it.

You'll then need to draft a letter of intent (LOI) to reflect your offer or counteroffer. The letter of intent is your opportunity to persuade the landlord that you would be an excellent tenant. This is especially advantageous in a commercial real estate market where space is in high demand.

The letter of intent should be considered a non-binding framework for negotiations. It should include, among other things, the party that will be leasing the property (including background information such as a description of the business and years of operation), intent to lease, and proposed terms. The terms can either be an acceptance of those proposed by the landlord’s broker, or a counter of the price, type of lease, or any number of negotiable items. With this, the negotiation process is underway.

Common Commercial Lease Terms

Regardless of the type of lease, commercial leases will often have similar lease terms. While the payment structure might differ, all leases include such things as the required deposit, the length of the lease, and more. Specifically, you’ll want to understand the following terms of your lease:

Use clause

This clause determines the type of business that can use the space. For example, some spaces are zoned for retail while others are zoned for office spaces. This use clause is particularly important if you expect to sublease your space in the future since it limits the businesses available to sublease.

Length of lease

Commercial leases typically range from 3 – 10 years. A short lease can be advantageous because it gives a business flexibility and reduces any future financial burdens.

Assignability

A lease has to be “assignable” if a business wants to eventually sublease the property. Further, an assignable lease makes it possible to include the lease in the sale of a business. For example, a restaurant with a great location might be bought out by another restaurant because the location is so good.

Capital expenditures

These expenditures determine who’s responsible for the repairs, maintenance, and other costs associated with the commercial property. A net lease, for example, charges a tenant for all the capital expenditures. A full-service lease, on the other hand, requires the landlord to cover all capital expenditures.

Rent and escalation

All leases stipulate not only the monthly and annual rent but also any future rent escalations. An escalation is a term that allows a landlord to legally increase the rent during the lease. It’s common to see rent escalations equal to 3% a year. Make sure that there are no abnormal escalations in your lease

Deposit

Most leases require a deposit. The deposit is fully refundable and protects the landlord from a delinquent tenant or a tenant that causes excessive damage to the property. The typical deposit is between 3 – 6 months rent.

Lease build-out credits

These credits represent the ability for a tenant to make leasehold improvements in their commercial space at the expense of the landlord. These expansions and improvements are necessary for the successful operation of the business. With build-out credits, landlords either offer a reduced rent, reimburse the tenants, or pay directly out of pocket.

Termination clause

Clause within the lease that allows the landlord and/or the tenant to terminate the agreement under certain conditions. Termination clauses are great if it allows you to terminate the agreement, but increases your risk if the landlord can also terminate the agreement.

Rent abatement

This term stipulates that if the commercial property is damaged, the tenant won’t have to pay rent (or pay a reduced rent) until the damage is fixed. This is a great way to reduce a business’s risk.

However, according to Carrie Wood, the Chief Marketing Officer of LeaseRef, the most overlooked item in a commercial lease is the building’s gross-up factor:

“The gross-up factor is the difference between the square footage of your actual useable area and the listed rentable area. This difference is a tenant’s proportionate share of common areas (mostly hallways and washrooms).
For instance, a suite that has 4,000 square feet of useable area usually is measured at approximately 4,500 square feet. But while you can only use 4,000 square feet, you’ll be charged for 4,500 square feet of space. This is by far the least understood lease clause by both brokers and tenants and the largest difference maker in commercial leases.”
When looking at your lease, you’ll want to negotiate terms so that you’re minimizing your gross up factor.