The Business Owner’s Guide to Types of Commercial Leases

March 7, 2024
valerielilaw.com

Commercial leases generally refer to leases of real property for non-residential uses. Examples include office, restaurant, retail, industrial/warehouse, or recreational use. They are differentiated from residential leases for single family or multifamily properties, even if those properties are owned by investors in the business of leasing homes to renters.

When negotiating a commercial lease, the type of lease used plays an important role in determining what the rent covers as well as the parties’ respective rights and responsibilities for taxes, insurance, and repair and maintenance of the leased premises. Because of these differences, it is important to understand whether the type of lease used is a net lease, gross lease, modified gross lease, or percentage lease.

In Southern California, many commercial landlords and tenants use templates created by AIR CRE (https://www.aircre.com/air-cre-contracts/list-of-contracts/). AIR CRE has different templates for different types of commercial properties. You can find templates for offices, shopping centers, and industrial leasing. You can also find templates tailored for single-unit properties, multi-tenant properties, and subleases. On the other hand, some commercial landlords opt to use custom leases unique to the landlord.

Regardless of whether you are using an AIR CRE template or a custom lease, both commercial landlords and tenants should review the lease in its entirety, understand the provisions, and negotiate favorable terms.

Common Types of Commercial Leases

 Full-Service (Gross) Leases

Under a full-service (gross) lease, the tenant typically pays a fixed rent and the landlord covers all property-related expenses. This means the landlord agrees to pay the costs of taxes, insurance, maintenance, and utilities. Those costs will be reflected in the lump sum rent charged to the tenant.

These types of leases are generally used for office and retail leases in office or retail complexes where there are numerous tenants. Landlords benefit from this kind of arrangement because they can pass on the property costs onto the tenant through the rent. Tenants likewise benefit because the fixed rent helps them to control their budgets with predictable monthly payments. In addition, the tenant will not have to do much in the way of property management.

 Net Leases

A tenant with a net lease typically pays a fixed base rent in addition to additional expenses. In exchange for lower base rents, tenants may agree to pay a greater range of property expenses:

  • In a single net lease, a tenant may pay for property taxes in addition to the base rent.
  • In a double net lease, a tenant may pay for base rent as well as property taxes and insurance.
  • In a triple net lease, a tenant may pay for the base rent plus property taxes, insurance, and maintenance of the property.

Although a lease may be titled a “single net,” “double net,” or “triple net,” the substance of each lease varies. A California appellate court actually cautioned against relying on the various titles or labels, explaining that they “have no legal significance” and do not ultimately determine how costs are allocated. (Tin Tin Corp. v. Pac. Rim Park, LLC (2009) 170 Cal.App.4th 1220, 1226.) Therefore, it is essential for the parties to understand and negotiate the substance of the lease provisions––do not assume that the title accurately reflects the substance of the lease.

Net leases may be used for any type of commercial property. Many retail stores, banks, restaurants, and gas stations use triple-net or double-net leases. These types of leases are more often used for properties with a single tenant leasing a property for 15 or 20 years. Tenants may benefit from leasing property for a long term without taking ownership because it frees up their cashflow for investing in their core business. Landlords may benefit from these types of leases because it reduces their property costs and day-to-day responsibilities managing the property.

Modified Gross Leases

A modified gross lease has the characteristics of a gross lease and a net lease. It requires the tenant to pay a base rent plus additional rent to cover its proportional share of operating expenses for the property, such as repairs, maintenance, utilities, taxes, and insurance. In many leases, common area maintenance fees (“CAM”) and other property costs are passed onto each tenant based on a calculation of square footage occupied or allocated to the tenant.

Because property costs and common area maintenance costs generally increase over time due to inflation, rise of labor costs, and other economic reasons, the leases will generally provide means for the landlord to pass on these increased costs. Landlords should make sure that the lease terms permit them to do this to minimize the landlords’ own costs. On the other hand, tenants should take care to negotiate and define the scope of those costs and increases to the tenants’ own advantage.

Gross modified leases are typically used for mixed-use or commercial properties where there is more than one tenant, such as a retail complex or an office building.

 Percentage Leases

A percentage lease calls for the tenant to pay a guaranteed minimum rent and a percentage of its gross sales or net profit (or any other measure the parties agree to) as rent. The percentage is generally based on how well the tenant’s business is doing at the premises––the parties will negotiate a natural or artificial breakpoint when the percentage rent applies. It is important for parties to negotiate the percentage rate, when the percentage rate is triggered (the breakpoint), and on what basis the percentage rent will be calculated. Because the percentage rent is built to allow fluctuations, tenants must pay attention these terms or risk the profitability of their businesses. Landlords who leverage this type of property will also need to

These types of leases are may be used for the leasing of retail and restaurant space. It allows landlords to share in the success of the business and tenants to potentially save on rent when revenues are lower. New or seasonal businesses may benefit from this type of lease, if able to obtain advantageous terms for the base rent and breakpoints. To ensure that landlords get the most of these types of leases, however, landlords will need to ensure that they have access to, and the ability to audit, the tenants’ financials. It may also make sense for landlords to build in terms that require the tenant to continue operating the business, even when the business proves unsuccessful. (College Block v. Atl. Richfield Co. (1998) 206 Cal.App.3d 1376, 1380.)

Conclusion

Whether you are using an AIR CRE template or unique lease, you do not need to accept the terms wholesale. Rather, you can and should negotiate terms that protect the interests of your investment. Before entering lease renewal negotiations or a brand-new lease agreement, we recommend seeking professional guidance to avoid pitfalls and help you obtain advantageous lease terms tailored to your specific needs.

Please note that the content provided on this website is for general information only; it is not intended to be and should not be construed as legal advice. If you need assistance understanding or negotiating your lease, please reach out to Valerie Li Law, A Professional Corporation, to schedule a consultation.