Leases, Rental

Real estate leases are typically broken down into the followingcategories, though occasionally you may see a creative combinationof more than one type:

The flat lease, which is the oldest and simplest type oflease, is becoming harder to find but is the best deal for thelessee 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 shortbecause a series of short-term leases could cost more in the longrun. If your rent term is short but you love your location, youcould wind up paying the landlord’s high rent increases over andover again.

The step lease attempts to second-guess what thelandlord’s expenses (for taxes, insurance and maintenance) will bein the future and compensates for them by increasing the rent eachyear. Therefore, the lease rate may make stepped increases likethese over the term of the agreement: 1st year, $1450/month; 2ndyear, $1480/month; 3rd year, $1510/month; 4th year, $1540/month;5th year, $1570/month.

The net lease takes the guesswork out of the step leaseproblem. You pay the base rent, and when the taxes go up, you paythe dollar increase or your share if more than one tenant is housedwithin the same facility. Where proportionate sharing occurs, yourshare is based on the square footage you occupy as a proportion ofthe 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 taxeson 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 peryear. 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 peryear. This method ensures that everyone pays his or her fairshare.

The double-net lease is a net-net version of the netlease that picks up added insurance premiums as well as taxincreases, singularly or on a proportionate basis. However, if youdo something in your business that raises insurance premiums, youalone will pick up the tab.

The triple-net lease is the most popular version of thenet lease and includes similar sharing by tenants of costs forrepairs to the building or parking area as well as taxes andinsurance.

The cost-of-living lease is different from the otherleases described above in that specific expense items aren’tincluded in this lease; instead, it takes inflation into account byreferring to the government’s Cost of Living Index. If, at the endof the year, inflation has been, say, 4.5 percent, your rent willincrease by that amount.

Landlords favor the percentage lease because it allowsthem to “share the wealth” of a tenant’s prospering business. Itsets a minimum or base rent to be paid and/or a percentage of thebusiness’ gross, whichever is the largest number. Such percentagescommonly run from 3 to 12 percent, depending on the area, type ofbusiness, and desirability of the location. These percentages areusually paid on a quarterly, semi-annual, or annual basis and areadjusted backward, though many shopping centers require a monthlyaccounting and payment.

The percentage lease is most common for properties in primeretail areas. Within those prime areas, specific locations (forexample, corner locations) may be subject to a higher percentagerate. If you have a percentage lease, the lessor will probablyrequire you to periodically furnish proof of gross sales. This isdone by examining your books, sales tax records, or, in some cases,by sending a copy of the appropriate attachment to your IRS Form1040.

What a Lease Covers
A rental lease usually covers any remodeling to the physicalstructure that needs to be done and specifies who will pay for it.Some of this remodeling is considered leasehold improvements. Thesecan include carpeting and other flooring, insulation, electricalwiring, plumbing, bathroom installations, lighting, wallpartitions, windows, ceiling tiles, painting, a sprinkler system,security systems, some elements of interior design, and sometimesheating and/or air conditioning systems.

Leasehold improvements in new shopping centers or malls are byfar the most extensive. Prospective operators often discover, totheir dismay, that the shopping center provides only concrete wallsand flooring. Although the cost of finish work often comes out ofthe retailer’s pocket, a construction allowance can sometimes benegotiated with the lessor to help offset the cost of someleasehold improvements.

Something else to keep in mind is that the time to ask for thatnew 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 ofaddendum that automatically becomes part of the lease. Make surethe lease specifies that the landlord is responsible for damagessuch as roof leaks, faulty plumbing, or old wiring. You’ll haveenough to think about running your business without worrying aboutyour building falling apart on you.

Don’t hassle your landlord with petty maintenance problems. Youshould be covered if your lease is written correctly, and yourattorney can tell you whether or not you are. Save yournegotiations for the big problems.

If you need to modify the premises, don’t be shy about askingthe landlord to cut appreciably or to forgo the first month’s rent.You might not get it, but on the other hand, you might bepleasantly surprised. Always point out that your business willincrease the value of the property with the improvements you’llmake to the facility from time to time.

Some leases include charges for common-area expenses such asmaintenance of walkways, landscaping, parking lots, and security.Though charging for these services is acceptable, some lessors tryto turn common-area charges into profit centers, adding on chargessuch as administration expenses.

Be wary of leases that give landlords the right to remodel atthe tenants’ expense without their prior approval.

If your location is in a shopping area, are there added costsfor maintenance of common areas? What are these costs? Are theyfixed or variable? What kind and amount of insurance does thelandlord require you to have? Are you paying for coverage thatshould be the landlord’s responsibility? If you’re in a smallcomplex, are you being charged for more than your share? Are theremunicipal or town merchant assessments for common customerparking?

A real estate lease usually covers other important matters, suchas any remodeling to be done, who pays for it, liabilities andduties assumed by each party, and permission for the tenant to putup signs, engage in additional lines of business, or make futurealterations, 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 benegotiated. If you accept the terms without discussion, you’vegiven up the opportunity to negotiate better terms. If you ask andthe lessor’s answer is no, you’ve lost nothing. You can always lookelsewhere and come back if you don’t find a better offer.

Real estate leases are a major financial commitment. Considernot only the present price per square foot, but also the price atthe end of the leasing term. Refer to your financial projections tosee if the lease will continue being affordable in the future.