Leases are complicated. They are usually long, full of redundancy, and include contradictory information. More so than residential leases, commercial leases are full of complications that often can only be understood by a legal professional.
The difficulties only increase when investing in retail or office properties due to the specific needs of each tenant and the longer length of a lease (usually longer than one year). While an apartment may require a six page lease, a retail space will normally have 30 plus pages and only increase in size and complexity with the type of tenant, size of space, and length of lease.
These complexities can become a hindrance to potential buyers as these leases are normally non-negotiable until the completion of the term regardless of ownership changing hands.
Luckily, these leases use common terminology which can assists potential buyers in the evaluation process. The following terms and types of clauses are some of the most common jargon you’ll see in a Commercial Real Estate lease:
Usable Square Footage:
In the lease, Usable Square Footage refers to the square footage which the tenant occupies. Normally this measurement will not include any square footage which may be considered to be “Common Areas”. Although the site plan may show one measurement, it normally will not be the measurement which ends up on the pages of the lease.
Right of First Refusal:
This clause can be either help or hurt the properties potential income depending on the market and current leases. What this clause does is require the landlord to offer one of the current lessees’ vacant space before offering the space to the general public.
On a positive note, if the tenant has this included in the lease, they usually have plans to expand and take on additional space.
On a negative note, if the property is in-demand in the market the clause will prevent you from stepping over current tenants to bring on better leases through new tenants.
Common Area Maintenance:
Referred to as CAM by many industry professionals, Common Area Maintenance is the operating expenses which the tenant will cover. This fee is normally assessed on a “Pro-Rata” basis, which means that the tenant will only cover a portion of the expense based on the percentage of the facility which they use.
The most important thing to remember with CAM charges is that there is no common standard as to what is included in the CAM charges, so having them defined in the lease is necessary. But keep in mind that landlords and tenants have two different desired outcomes here. Landlords want CAM charges to be broad in order trickle most expenses down to the tenants, whereas the tenants want a narrowly defined set of CAM charges to keep the money owed low.
Co-Tenancy Clauses can mean the difference between collecting additional rent, marketing fees, and other items that only occur when a certain percentage of a shopping center or mall are occupied. Depending on the clause, tenants can even have the option back out of their lease if the co-tenancy is not achieved for a certain length of time.
Co-tenancy requirements often vary lease by lease and can involve a range of options for what’s included when co-tenancy is achieved versus when it isn’t. Make sure to pay particular attention to these since there is so much variability.
The use of these different terms and clauses, in addition to hundreds of others, is often a part of the strategic decision-making process. Knowing these terms will put you in the best position when either negotiating your purchase price or when re-signing tenants at the end of the lease term.
Remember, these are not the only terms which you will come across when investing in commercial real estate and you will need to be prepared for them.
If you would like to find out about additional leasing terms and how to use them to further your own financial goals, please join us for one of our upcoming Commercial Property Academy live events. Do not let another opportunity pass you by. Register Today!