Definition: An agreement between a landlord and a tenant that gives the tenant
the right to use and occupy rental property for a period of time
Real estate leases are typically broken down into the following
categories, though occasionally you may see a creative combination
of more than one type:
The flat lease, which is the oldest and simplest type of
lease, is becoming harder to find but is the best deal for the
lessee because it's based on a set price for a set period of time.
The danger here is not to be tempted if the term is too short
because a series of short-term leases could cost more in the long
run. If your rent term is short but you love your location, you
could wind up paying the landlord's high rent increases over and
over again.
The step lease attempts to second-guess what the
landlord's expenses (for taxes, insurance and maintenance) will be
in the future and compensates for them by increasing the rent each
year. Therefore, the lease rate may make stepped increases like
these over the term of the agreement: 1st year, $1450/month; 2nd
year, $1480/month; 3rd year, $1510/month; 4th year, $1540/month;
5th year, $1570/month.
The net lease takes the guesswork out of the step lease
problem. You pay the base rent, and when the taxes go up, you pay
the dollar increase or your share if more than one tenant is housed
within the same facility. Where proportionate sharing occurs, your
share is based on the square footage you occupy as a proportion of
the total size of the facility. If store A has 1,450 square feet,
store B has 2,400 square feet, and store C has 850 square feet,
then the building has a total of 4,700 square feet. Let's say taxes
on the building property are $880, or 18.7 cents per square foot.
So store A's share of the tax is $1,450 x 18.7 cents or $271.15 per
year. Store B's share is $2,400 x 18.7 cents or $448.80 per year,
and store C's tax increase is $850 x 18.7 cents or $158.95 per
year. This method ensures that everyone pays his or her fair
share.
The double-net lease is a net-net version of the net
lease that picks up added insurance premiums as well as tax
increases, singularly or on a proportionate basis. However, if you
do something in your business that raises insurance premiums, you
alone will pick up the tab.
The triple-net lease is the most popular version of the
net lease and includes similar sharing by tenants of costs for
repairs to the building or parking area as well as taxes and
insurance.
The cost-of-living lease is different from the other
leases described above in that specific expense items aren't
included in this lease; instead, it takes inflation into account by
referring to the government's Cost of Living Index. If, at the end
of the year, inflation has been, say, 4.5 percent, your rent will
increase by that amount.
Landlords favor the percentage lease because it allows
them to "share the wealth" of a tenant's prospering business. It
sets a minimum or base rent to be paid and/or a percentage of the
business' gross, whichever is the largest number. Such percentages
commonly run from 3 to 12 percent, depending on the area, type of
business, and desirability of the location. These percentages are
usually paid on a quarterly, semi-annual, or annual basis and are
adjusted backward, though many shopping centers require a monthly
accounting and payment.
The percentage lease is most common for properties in prime
retail areas. Within those prime areas, specific locations (for
example, corner locations) may be subject to a higher percentage
rate. If you have a percentage lease, the lessor will probably
require you to periodically furnish proof of gross sales. This is
done by examining your books, sales tax records, or, in some cases,
by sending a copy of the appropriate attachment to your IRS Form
1040.
What a Lease Covers
A rental lease usually covers any remodeling to the physical
structure that needs to be done and specifies who will pay for it.
Some of this remodeling is considered leasehold improvements. These
can include carpeting and other flooring, insulation, electrical
wiring, plumbing, bathroom installations, lighting, wall
partitions, windows, ceiling tiles, painting, a sprinkler system,
security systems, some elements of interior design, and sometimes
heating and/or air conditioning systems.
Leasehold improvements in new shopping centers or malls are by
far the most extensive. Prospective operators often discover, to
their dismay, that the shopping center provides only concrete walls
and flooring. Although the cost of finish work often comes out of
the retailer's pocket, a construction allowance can sometimes be
negotiated with the lessor to help offset the cost of some
leasehold improvements.
Something else to keep in mind is that the time to ask for that
new coat of paint--outside or inside--is before you sign the lease.
Get it in writing, if not in the lease itself, then by a letter of
addendum that automatically becomes part of the lease. Make sure
the lease specifies that the landlord is responsible for damages
such as roof leaks, faulty plumbing, or old wiring. You'll have
enough to think about running your business without worrying about
your building falling apart on you.
Don't hassle your landlord with petty maintenance problems. You
should be covered if your lease is written correctly, and your
attorney can tell you whether or not you are. Save your
negotiations for the big problems.
If you need to modify the premises, don't be shy about asking
the landlord to cut appreciably or to forgo the first month's rent.
You might not get it, but on the other hand, you might be
pleasantly surprised. Always point out that your business will
increase the value of the property with the improvements you'll
make to the facility from time to time.
Some leases include charges for common-area expenses such as
maintenance of walkways, landscaping, parking lots, and security.
Though charging for these services is acceptable, some lessors try
to turn common-area charges into profit centers, adding on charges
such as administration expenses.
Be wary of leases that give landlords the right to remodel at
the tenants' expense without their prior approval.
If your location is in a shopping area, are there added costs
for maintenance of common areas? What are these costs? Are they
fixed or variable? What kind and amount of insurance does the
landlord require you to have? Are you paying for coverage that
should be the landlord's responsibility? If you're in a small
complex, are you being charged for more than your share? Are there
municipal or town merchant assessments for common customer
parking?
A real estate lease usually covers other important matters, such
as any remodeling to be done, who pays for it, liabilities and
duties assumed by each party, and permission for the tenant to put
up signs, engage in additional lines of business, or make future
alterations, if needed. Since a lease is a binding legal document,
you must seek competent legal counsel before signing one.
Remember that leases aren't engraved in stone and can usually be
negotiated. If you accept the terms without discussion, you've
given up the opportunity to negotiate better terms. If you ask and
the lessor's answer is no, you've lost nothing. You can always look
elsewhere and come back if you don't find a better offer.
Real estate leases are a major financial commitment. Consider
not only the present price per square foot, but also the price at
the end of the leasing term. Refer to your financial projections to
see if the lease will continue being affordable in the future.