Mike Byrum
Mainsail Development Group
April 27, 2007
Real estate is an important element of the delivery model of most businesses. Your real estate decision plays a key role in determining the environment in which your business interacts with its customers / clients, the market from which your business draws customers, and who those customers are. Obviously, all of these roles impact very significant components of your business plan.
Therefore, at some point, you will find yourself with the crucial task of negotiating to buy or lease commercial real estate. If you were to choose to lease, it would not be uncommon for you to encounter a 50 page lease document that covered over three dozen issues.
There are several different types of commercial leases. They range from a gross lease, where the tenant’s occupancy costs remain constant throughout the year regardless of what it costs the landlord to operate and maintain the property, to triple net leases, where upkeep expenses are passed through to the tenant, making the tenant responsible for any fluctuations in those costs. Gross leases are primarily found in office markets, where triple net leases are found in retail markets. For the purposes of our discussion here, we will focus on triple net leases.
Of the issues covered in a lease document, the key issues will likely include base rent, annual escalation of base rent, additional rent, the use clause, and parking requirements.
Base rent is typically calculated as a cost per square foot on an annual basis in the Orlando market. For example, if you are leasing 1,200 square feet at $30 per square foot, your rent payments will total $36,000 for the year, or $3,000 per month.
Base rent normally increases beginning on the 13th month of each year and does so every 12 months thereafter through rent escalation. This escalator can be a percentage by which base rent increases each year for the length of the lease. Using this method, if your first year rent is $30.00 per square foot and your annual escalator is 3%, your second year rent would be $30.90 per square foot. Escalation is sometimes is tied to the Consumer Price Index, where the percentage by which rent escalates is equal to CPI. It can also escalate by a straight dollar figure year to year (if first year’s rent is $30.00 per square foot and the escalator is $1.00, second year’s rent would equal $31.00 per square foot).
Additional rent, or “pass-through’s,” are the operating and maintenance costs associated with a property that tenants are required to pay under a triple net lease. They typically will consist of common area maintenance (i.e. landscaping, garbage service, etc.), real estate taxes, and real estate insurance on the property. These expenses are generally paid as a tenant’s pro rata share based on the square footage of the space they occupy compared to the square footage of the total property. If you occupy 5,000 square feet in a 50,000 square foot property, you will pay 10% of the property expenses.
The use clause dictates the business you are permitted to operate within the space that you lease. This serves both landlord and tenant. If your business is selling coffee and another user in the center sells clothes, and your business is flourishing while the clothing business struggles, you would not want to show up one morning to find your clothier neighbor selling coffee. The use clause prevents this from happening.
Your allotment of parking is figured as a number of parking spaces per 1,000 square feet that you occupy. If you were to occupy 2,000 square feet and you were allotted four spaces per 1,000 square feet, you would have eight spaces available for your use. This is important because you need to have the ability to accommodate your employees and clientele at your location.
Your ability to negotiate appropriate terms in regards to these issues has a vital impact on your business as it directly affects your business’ profitability and operations. I strongly encourage you to familiarize yourself with these terms as you seek to grow your business.
