By: Rajesh K. Sharma, Advocate (LinkedIn)
Commercial Leases can be classified on the basis of Subject Matter and Financial Structure.
Commercial Leases on the basis of Subject Matter
On the basis of Subject Matter, Commercial Leases can be further divided into three types:-
1. Industrial Leases:
Used for manufacturing, warehousing, and distribution. Generally simpler, with tenants often responsible for maintenance and repair. Environmental provisions are crucial due to the nature of industrial operations.
2. Office Leases:
Pertaining to spaces used for professional services. More detailed, with tenants relying on landlords for various services like HVAC and elevator maintenance. Restoration obligations are often a focus.
3. Retail Leases:
For businesses that sell goods or services directly to consumers. Highly integrated, with landlords exerting control over use, signage, and tenant mix to maintain the retail center's viability. Exclusive-use rights and continuous operation clauses are common.
The following chart outlines the key differences and characteristics of industrial, office, and retail leases.
Aspect | Industrial Leases | Office Leases | Retail Leases |
Typical Provisions | Basic, with fewer additional provisions | Moderate complexity, more service dependencies | High complexity, many additional provisions |
Maintenance & Repairs | More responsibilities on the tenant | Landlord provides many services, tenant depends on landlord | High integration, responsibilities vary |
Environmental Issues | Significant, detailed environmental provisions | Less focus on environmental issues | Variable, depending on the type of retail space |
Use Restrictions | Often fewer restrictions | Moderate restrictions | Strict restrictions to maintain tenant mix and use |
Signage Rights | Usually fewer signage rights | Moderate signage rights | Critical, includes pylon sign rights |
Occupancy Obligation | Typically not required | Not necessarily required | Often required to continuously occupy the premises |
Relocation Rights | Rarely included | Sometimes included | Often included |
Measurement of Area | To exterior face of all exterior walls | To inside face of glass or exterior walls, center line of interior walls | To exterior face of exterior walls, center line of interior walls |
Common Area Inclusion | Usually no inclusion of common areas | Includes a pro-rata share of common areas | Generally no gross-up for common areas |
End-of-Term Restoration | Less focus, depends on tenant's use | Often more focus, can be costly | Variable, but often includes obligations to refresh or restore |
Landlord-Tenant Relationship | Less integrated, more self-sufficient | Moderately integrated | Highly integrated, akin to a partnership |
Commercial Leases on the basis of Financial Structure
Commercial leases can be categorized based on their financial structure, determining how rent and additional costs are allocated between the landlord and tenant. The three main types are net leases, gross leases, and percentage leases.
1. Net Leases
Net leases require tenants to pay a base rent plus additional expenses associated with the property. There are several variations:
- Single Net Lease (N): The tenant pays base rent plus property taxes. The landlord covers other expenses like maintenance and insurance.
- Double Net Lease (NN): The tenant pays base rent, property taxes, and insurance premiums. The landlord remains responsible for maintenance costs.
- Triple Net Lease (NNN): The tenant pays base rent, property taxes, insurance, and maintenance costs. This structure shifts most financial responsibilities to the tenant, providing predictable income for the landlord.
Example: A tenant leasing a retail space under a triple net lease would pay the base rent and also cover property taxes, insurance premiums, and maintenance costs for the building.
2. Gross Leases
Gross leases involve a single, all-inclusive rent payment that covers all property-related expenses. The landlord is responsible for paying property taxes, insurance, and maintenance costs from the rent collected.
Full-Service Gross Lease: The landlord provides a range of services, such as utilities, janitorial services, and building maintenance, included in the rent.
Example: In an office lease with a full-service gross lease, the tenant pays one monthly rent amount, and the landlord covers all other costs associated with operating and maintaining the property.
3. Percentage Leases
Percentage leases are commonly used in retail properties, where the tenant pays a base rent plus a percentage of their gross sales. This structure aligns the landlord’s income with the tenant’s business success.
Standard Percentage Lease: The tenant pays a lower base rent and a percentage of gross sales over a specified breakpoint.
Modified Percentage Lease: Similar to the standard, but the percentage rent is calculated differently or includes other specific conditions.
Example: A tenant in a shopping mall might pay a base rent plus 5% of gross sales exceeding a certain amount each month, providing the landlord with additional income if the tenant’s business performs well.
4. Mixed Financial Structures
Some leases combine elements of the above structures, creating semi-gross leases or escalating leases. These arrangements might fix certain costs for the initial period and include provisions for increases over time, often tied to inflation or other indices.
Example: A semi-gross lease might include base rent with fixed utility costs for the first year, with adjustments for inflation in subsequent years.