Understanding the Costs of Commercial Leases

When a small business owner is considering renting a commercial property (whether it’s an office, retail space or a warehouse), it’s important to know the kinds of payments that will be required. A commercial lease is a long-term commitment with significant financial responsibilities. Often times, a landlord requires a personal guaranty on the lease which creates personal liability on the business owner(s). If the business tenant does not pay rent (or other sums due) then the landlord can collect from the business owner(s) personally. This creates a significant financial risk and smart business owners pay close attention to the language in the lease agreement.

Here’s a rundown of some of the financial commitments that are often found in commercial leases:

Base Rent – Base rent can be set out in the lease as a specific sum every month or it can be set out as a specific sum per square foot of the leased premises. If it’s set out per square foot, to find the monthly payment, you multiply the square footage of the premises by the amount per square foot and that is the annual rental amount. You then divide the annual amount by twelve months to find the base rent per month. Sometimes, a commercial lease will set out the base rent amount per year of the lease term and other times it will only set out the base rent for the first year and provide for an annual increase by a certain percentage. For example, a lease could have a base rent at $16.00 per square foot with a 3% increase every year during the lease term.

Additional Rent – Additional Rent is a term that will be defined in the lease. Depending on the type of lease, it could include property taxes, insurance and common area maintenance fees (“CAM”), all of which are described below.

Percentage Rent – Percentage rent is not as common in today’s market, but we sometimes see this type of rent at high traffic locations. Percentage rent is in addition to the base rent and it is based on revenues of the business. Financial statements must be provided to the landlord and the amount of percentage rent is calculated monthly and sometimes quarterly.

Taxes
Sales Tax – In Florida, sales tax is charged on commercial rent payments so a business tenant will pay sales tax on the amount of rent each month. Depending on how the lease is worded, sales tax may also be charged on the insurance and CAM payments.

Property Tax – In addition to sales tax, the lease may require the payment of property taxes for the location. The landlord normally will calculate estimated property taxes and charge a prorated amount each month. At the end of the taxable period, if there is a shortage the landlord will charge the difference. If there is an overage, the landlord usually applies that amount to the next payment.

Insurance – Most leases require a business tenant to have a certain amount of insurance coverage. These policies would be in the business tenant’s name and the premiums would be paid directly to the insurance company. (It’s always a good idea to get the insurance quotes before the lease is signed. Insurance premiums can be more than anticipated.) In addition to the business tenant’s own policies, some leases require the business tenant to pay the premiums for the landlord’s policies on the property (or a pro-rated portion).

CAM – CAM or Common Area Maintenance Fees are sometimes charged in shopping centers or multi-tenant properties. These are the operating costs that the landlord incurs in maintaining and repairing the areas that all tenants can access. Some, but not all, of these areas could include the sidewalks, parking lots, courtyards, elevators, stairwells, and landscaping. The lease should define what is included in CAM and what is not included (such as capital improvements). The amount of CAM a business tenant pays each month is based on an estimate by the landlord and it is reconciled at the end of each year. Often, small business owners underestimate the effect that CAM has on the total amount of rent they pay.

Repair & Maintenance – Depending on the type of lease, business tenants may be required to pay for maintenance and repairs to the leased premises. Some of the most expensive repairs can include repairs to utility pipes, electrical systems and HVAC systems. Knowing the condition of these particular parts of the leased premises before the lease is signed is critical. If possible, it is wise to set limits on the cost of repairs, especially for HVAC systems. In commercial properties, it is the luck of the draw as to the tenant who has to deal with a run-down or broken HVAC unit.

Our Practical Tip:  Before a lease is signed, create a spreadsheet of all of the definite and potential costs of renting the space. Include the above if they are required in the lease, but also include any additional obligations, such as trash collection, required service contracts, signage costs and costs of improvements and renovations. Once all of the costs and potential costs are listed, it is easier to compare different spaces and to determine the best location that fits into the business budget.