Leases, Rental

By Entrepreneur Staff


Leases, Rental 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.

More from Location

Leases, Rental

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

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The physical space where your business exists

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