As we have seen over the past several years post-COVID, some businesses can thrive in a fully remote, “work from home” setting, but there will always be a need for commercial space for businesses that either need or prefer to operate in a physical location separate from their home. While some businesses may purchase commercial real estate for this purpose, many others will enter into a lease agreement to rent their commercial space.
Commercial leases are a different animal than your standard residential lease and often far more complex. Unlike residential tenancies, there are considerably fewer statutory protections under Florida law for a commercial or business tenant. For example, aside from the standard radon gas disclosure, there are no mandatory disclosures to commercial tenants regarding the leased premises, no statutory or implied warranty of habitability, and no statutory duty of the landlord to make repairs.
The parties to a commercial lease have more latitude to craft their own agreement under general contracting principles, and there are a number of issues for both the landlord and tenant to consider and address in their lease document. As a result, commercial lease agreements vary greatly in terms of length and complexity. Common matters of concern include the calculation and payment of rent and other expense reimbursements, allocation of responsibility for repairs and maintenance, provisions for tenant improvements or buildouts, extension or renewal options, expansion rights, signage, parking, and personal guarantees. Each of the foregoing could easily be the subject of its own article but suffice it to say there are many issues to consider when it comes to a commercial lease agreement.
Even the most basic of terms—the amount of rent to be paid for the tenant’s use of the leased premises—is not always so simple in the commercial context. The calculation of rent payable to the landlord can vary depending on the type of space being leased (e.g., industrial, retail, office). Base or fixed rent is the most straightforward form of rent and common with office leases. In contrast, a lease for retail space in a shopping center may have variable rent, known as percentage rent, which can be a minimum rent amount or an amount of rent that is based on a percentage of the tenant’s gross sales or net profits, or some combination of the two. Additionally, it is not uncommon for there to be terms in the lease that call for rent adjustments or escalations, either on an annual basis and/or upon exercise of a renewal option. These adjustments can be a fixed amount or percentage or can be tied to external factors such as the consumer price index.
Also, commercial tenants are often required to reimburse the landlord for various operating expenses in addition to paying base rent. There are different lease types depending on how the lease handles the tenant’s reimbursement of its proportionate share of these operating expenses. Operating expenses are those expenses incurred by the landlord related to the operation of the building/shopping center/development in which the premises is located. These can include real estate taxes, insurance, repairs and maintenance, and anything else that may be defined as being part of operating expenses in the lease document (and this definition can sometimes be quite expansive).
There are three basic lease types: gross lease, net lease, and base year lease, although in practice it is more common for leases to be some modified or hybrid version of these types. The true full-service gross lease is where the tenant’s share of operating expenses is included in the fixed rental payment amount and is the simplest form. A true gross lease is rare; it is more common to have a modified gross lease where the tenant pays some operating expenses.
Under a net lease the operating expenses are calculated and paid separately by the tenant and are not included in the base rent amount. Typically, the tenant pays an estimated amount of these operating expenses, and at the end of each year the landlord reconciles the tenant’s account based on the actual operating expenses incurred by the landlord. There are different variations of the net lease: the single net lease, the double net lease or “net-net” lease, and the triple net lease or “net-net-net” lease. Generally, the distinction between these variations relates to the tenant’s responsibility for paying one or more of the real estate taxes, insurance, and/or repair and maintenance costs (sometimes referred to as common area maintenance or “CAM”). Under a single net lease, the tenant is responsible for paying only one of these categories of expenses (e.g., only real estate taxes); whereas under a double net lease, the tenant is responsible for two of these expenses (e.g., real estate taxes and insurance), and likewise, with a triple net lease, the tenant is responsible for paying all three categories of expenses (e.g., real estate taxes, insurance, and CAM). While these variations are helpful guideposts, practically speaking, the lease may end up being a hybrid version, particularly after the lease terms have been further negotiated by the parties.
The last type of lease is the base year lease, sometimes referred to as a modified gross lease. With this type of lease, the operating expenses are included as part of base rent, similar to a gross lease; however, the tenant is responsible for paying its proportionate share of any increase in the operating expenses above the expenses in the base year. The “base year” is identified in the lease and establishes the baseline amount for each of the various categories of expenses. A modified version of the base year lease is an expense stop lease, which accomplishes the same thing but simply specifies an amount of operating expenses to establish a baseline instead of referring to the expenses incurred in a particular base year.
With these types of leases, as well as net leases, there are often extensive provisions in the lease addressing the calculation and reconciliation of operating expenses, as well as related provisions such as operating expense caps and gross-up provisions, which the tenant or landlord may seek to negotiate into the lease terms.
This just scratches the surface as there are numerous other intricacies with a commercial lease to consider. Needless to say, as with any contract, it is imperative to carefully review the terms of a commercial lease to ensure that it accurately captures the parties’ intent and expectations. Whether you are a commercial landlord or tenant, engaging the assistance of competent legal counsel with experience in drafting and reviewing commercial lease agreements can help you navigate the myriad of issues that can arise when negotiating the terms of a commercial lease.
This article is for general information only and is not intended as and does not constitute legal advice or solicitation of a prospective client. It should not be relied on for legal advice in any particular factual circumstance.