Commercial Real Estate Leasing | Comprehensive Guide

Your Comprehensive Guide To Commercial Real Estate Leasing In Texas

Inna Radford | 20th May 2024 | 10 minute read

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What Is Commercial Real Estate Leasing?

When you think of commercial real estate leasing, envision the dynamic spaces that cater to a myriad of business activities. These aren’t just generic office buildings or storefronts – they’re versatile environments tailored to the diverse needs of businesses, from bustling retail shops to sophisticated corporate offices.

Commercial real estate leasing encompasses a broad spectrum of property types, each serving a specific function within the business ecosystem. Retail spaces, for instance, range from small boutique shops to sprawling shopping centers, each designed to attract and accommodate a steady stream of customers. Office spaces vary from sleek high-rises in urban centers to suburban business parks, providing the necessary infrastructure for companies to operate efficiently and effectively.

One common characteristic of these properties is their strategic location. Retail properties often occupy prime spots in high-traffic areas to maximize visibility and foot traffic, while office spaces are frequently situated in accessible locations with ample parking and public transit options. This strategic positioning is crucial for businesses to thrive and grow.

Commercial leases are typically more complex than residential leases, reflecting the intricate needs of the businesses they serve. Lease agreements can include a variety of terms, such as rent structures (which might involve base rent plus a percentage of sales for retail), lease duration, maintenance responsibilities, and options for renewal or expansion. Understanding these terms is essential for both landlords and tenants to ensure a mutually beneficial arrangement.

While commercial real estate may not always be the public face of a business, it provides the essential infrastructure that supports day-to-day operations. These spaces are the stage where businesses conduct their core activities, whether it’s selling products, providing services, or managing corporate affairs. Thus, commercial real estate leasing is a crucial component of the business world, enabling companies to establish their presence and flourish in a competitive market.

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What Types Of Commercial Lease Agreement Are There?

In a Triple Net Lease (NNN), tenants not only pay a base rent but also cover additional expenses, including property taxes, insurance for common areas and the building exterior, and maintenance costs for shared spaces. 


This means tenants are responsible for reimbursing the landlord for these expenses, in addition to their base rent. 


Landlords typically retain responsibility for structural repairs, such as those to the roof, foundation, and exterior walls. However, tenants are accountable for all maintenance, repairs, and insurance pertaining to the interior of their leased spaces.

An Absolute Net Lease, also known as a “Zero Landlord Responsibility” lease, is a contractual agreement in which the landlord receives the base rent from the tenant. However, unlike other lease types where the landlord may cover certain expenses, in an Absolute Net Lease, the tenant bears the responsibility for all costs associated with the property.


This includes paying property taxes, insurance premiums, and expenses related to maintenance and repairs, including those for the building’s structure. 


Essentially, the tenant assumes full financial responsibility for the property, leaving the landlord with no obligations beyond collecting rent. These leases are particularly common in single-tenant buildings, where the tenant typically operates the entire property and thus assumes all associated costs and risks.

A Modified Gross Lease is a type of lease agreement commonly used in commercial real estate. In this arrangement, the monthly rental payments initially include building expenses for a specific base year, which is agreed upon by both parties. These building expenses typically include items such as property taxes, insurance premiums, and maintenance costs.


During the base year, the tenant pays a set amount each month, which covers their share of these building expenses. However, in subsequent years of the lease term, if the building expenses increase above the levels set in the base year, the tenant is required to reimburse the landlord for the difference. This ensures that the landlord is not financially burdened by rising expenses beyond what was initially anticipated.


One key feature of a Modified Gross Lease is that utilities may or may not be included in the lease agreement. This depends on the specific terms negotiated between the landlord and tenant.


Overall, a Modified Gross Lease provides a structured approach to managing building expenses, with tenants sharing in any increases beyond the base year while still maintaining some predictability and control over their monthly costs.

A ground lease is a contractual arrangement where a tenant leases land from a landlord for a specified period. The tenant is then responsible for constructing a building on the leased land at their expense. In addition to paying rent for the land, the tenant is also obligated to cover all building-related expenses, including insurance premiums and property taxes.


Unlike other lease types where the tenant leases both land and building, in a ground lease, the tenant only leases the land. The ownership of the building typically remains with the tenant throughout the lease term.


However, upon the expiration or early termination of the ground lease, ownership of the building reverts to the landlord. This means that at the end of the lease term, the landlord becomes the owner of the building, regardless of the tenant’s investment in its construction.


In summary, a ground lease allows a tenant to lease land, build a structure on it, and operate their business, while ultimately surrendering ownership of the building to the landlord once the lease term concludes.

A percentage lease is a type of commercial lease agreement where the tenant pays a percentage of their sales revenue to the landlord, in addition to or instead of the scheduled base rental payments.


In this arrangement, the amount of rent paid by the tenant is directly tied to the tenant’s business performance. The landlord typically benefits from higher rental income when the tenant’s sales increase, reflecting the success of the tenant’s business.


Additionally, the tenant may also be responsible for paying certain expenses such as property taxes, insurance, and building maintenance or repair costs, depending on the terms negotiated in the lease agreement.


Overall, a percentage lease provides both the landlord and the tenant with a vested interest in the success of the tenant’s business, as the rental payments are directly linked to the tenant’s sales performance.

Commercial Real Estate Terms & Definitions

The Initial Term in a commercial lease refers to the duration for which the tenant is initially committing to lease the property. It represents the number of years specified in the lease agreement during which the tenant has the right to occupy and utilize the leased space according to the terms outlined in the lease.

For example, if a tenant signs a commercial lease with an Initial Term of five years, it means they are committing to lease the property for a period of five years from the lease commencement date. At the end of the Initial Term, the lease may be renewed, renegotiated, or terminated, depending on the terms agreed upon in the lease agreement.

An additional term granted to tenant by landlord, which tenant does not need to commit to. It is optional, and tenant may choose to use it or not later.

In commercial real estate, “premises” refers to the specific space that a tenant leases and occupies. There are various types of premises, including:

1. Single-Tenant Premises: This refers to a space occupied by a single tenant who has exclusive use of the entire space.

2. Multi-Tenant Premises: This refers to a space that is divided into multiple units or suites, each leased to different tenants who share common areas such as hallways, restrooms, and parking lots.

3. Retail Premises: These are spaces specifically designed for retail businesses, such as storefronts in shopping centers or standalone retail buildings.

4. Office Premises: These are spaces designed for office use, including office buildings, coworking spaces, and business parks.

5. Industrial Premises: These are spaces used for industrial purposes, such as warehouses, manufacturing facilities, and distribution centers.

6. Mixed-Use Premises: These are spaces that combine two or more types of uses, such as retail and residential or office and retail.

Overall, the type of premises chosen depends on the specific needs and requirements of the tenant’s business.

A common area in commercial real estate refers to shared spaces within a property that are utilized by multiple tenants and customers. These areas are typically maintained and managed by the property owner or landlord. Common areas may include:

1. Parking Lots: Spaces designated for parking vehicles, including parking stalls, aisles, and driveways.

2. Landscaped Areas: Green spaces within the property that are landscaped with plants, trees, and shrubs for aesthetic purposes.

3. Sidewalks: Pathways or walkways adjacent to the building that provide pedestrian access to the property.

4. Driveways: Access lanes or roads leading to the property, often used for vehicle ingress and egress.

5. Entrances and Exits: Areas around building entrances and exits that are used for entering and exiting the property.

6. Lobbies and Corridors: Interior spaces within the building that are shared by multiple tenants and provide access to individual leased spaces.

The Tenant Improvement Allowance, also known as TI money, Build-out allowance, or build out credit, is a one-time payment provided by the landlord to the tenant to cover a portion of the costs associated with customizing or improving the leased space to fit the tenant’s specific needs.

This allowance is typically offered for spaces that have never been occupied before or require significant alterations to meet the tenant’s requirements. The tenant is responsible for covering the remaining construction costs beyond the allowance amount.

Essentially, the Tenant Improvement Allowance serves as financial assistance from the landlord to the tenant for the purpose of renovating or constructing improvements within the leased premises. It enables the tenant to customize the space to their liking without bearing the full financial burden of construction expenses.

Base Rent (aka the minimum guaranteed rent)

Base rent, also known as minimum guaranteed rent, is the fixed amount of rental payment agreed upon between the landlord and the tenant in a lease agreement. It is the foundational component of the rent structure for commercial real estate leases.

The base rent is typically determined based on various factors such as the size and location of the leased space, market conditions, and the terms negotiated between the parties. It is often expressed as a dollar amount per square foot per year (e.g., $30 per square foot per year).

Unlike additional rent components such as operating expenses or utilities, which may fluctuate based on factors like property taxes or maintenance costs, the base rent remains constant throughout the lease term, unless specified otherwise in the lease agreement.

Base rent serves as the starting point for calculating the total rent payable by the tenant. It is essential for both parties to clearly understand and agree upon the base rent, as it forms the core financial obligation of the tenant under the lease agreement.

To calculate the base rent for a commercial lease, follow these steps:

  1. Identify the quoted rate: This is the dollar amount per square foot per year that is agreed upon in the lease agreement.

  2. Determine the size of your space: Measure the square footage of the area you are leasing.

  3. Multiply the quoted rate by the size of your space: Multiply the quoted rate by the square footage of your leased space.

  4. Divide by 12 months: Since the quoted rate is typically an annual amount, divide the result from step 3 by 12 to find the monthly base rent.

For example, if the quoted rate is $30 per square foot per year and your leased space is 1,300 square feet:

Base Rent = ($30/sq ft/yr) x 1,300 sq ft / 12 months = $3,250 per month

So, the base rent for your lease would be $3,250 per month.

Delivery Condition Types

The delivery condition refers to the state or condition of the leased space as provided by the landlord to the tenant at the beginning of the lease term. It outlines the condition of the premises when the tenant takes possession and begins occupancy.

This condition can vary depending on the terms negotiated in the lease agreement. It may include factors such as the state of the interior finishes, the presence of any existing fixtures or equipment, and the overall cleanliness and functionality of the space.

Understanding the delivery condition is important for both landlords and tenants as it clarifies their respective responsibilities for any necessary repairs, improvements, or alterations to the premises during the lease term.

For example, if a tenant signs a commercial lease with an Initial Term of five years, it means they are committing to lease the property for a period of five years from the lease commencement date. At the end of the Initial Term, the lease may be renewed, renegotiated, or terminated, depending on the terms agreed upon in the lease agreement.

A premises in “Grey Shell” condition refers to a space within a real estate property that has never been built out or occupied before. In this state, the space is essentially a blank canvas, lacking essential amenities and infrastructure typically found in finished commercial spaces.

Specifically, a Grey Shell space does not include HVAC (heating, ventilation, and air conditioning) systems, bathrooms, or distributed electric lines or panels inside. This means that the space does not have climate control, restroom facilities, or electrical wiring installed throughout.

Essentially, a Grey Shell space provides a basic foundation for tenants to customize and build out according to their specific needs and requirements. Tenants leasing a Grey Shell space are responsible for completing the necessary construction and installations to transform the space into a functional and operational environment for their business.

A premises in “Vanilla Shell” condition, also known as “White Shell” or “White Box”, refers to a space within a real estate property that has basic finishes and amenities already installed, providing a foundation for further customization by tenants.

In a Vanilla Shell space, tenants can expect:

1. One bathroom: Typically, the space includes one restroom facility.

2. Walls primed and ready for paint: The walls have been prepared for painting but may require the tenant’s choice of paint color.

3. Leveled concrete floor: The floor is smooth and level, providing a suitable base for carpeting or other flooring materials chosen by the tenant.

4. HVAC system: Heating, ventilation, and air conditioning systems are installed to regulate indoor climate control.

5. White drop ceiling: A suspended ceiling system is in place, typically finished in white, providing a clean and uniform appearance.

6. Basic electric package: The space is equipped with basic electrical wiring and outlets, allowing for standard electrical usage.

A commercial real estate premise described as “AS IS” means that the space is being offered in its current condition, exactly as it appears at the time of viewing or leasing. This term implies that no improvements, alterations, or repairs will be made by the landlord prior to the tenant taking possession.

In practical terms, this means that the tenant must accept the space in its current state, including any visible wear and tear, cosmetic issues, or functional deficiencies. The landlord is not obligated to make any changes or upgrades to the premises before leasing it to the tenant.

Tenants considering leasing a commercial space “AS IS” should carefully inspect the premises to assess its condition and determine whether it meets their needs and expectations. They should also consider the costs and efforts required to make any desired improvements or modifications themselves, as these responsibilities typically fall on the tenant in an “AS IS” lease arrangement.

A commercial real estate premise described as “Broom Clean” signifies that the space has been cleared of all debris and rubbish, leaving it in a tidy and orderly condition.

This term implies that the landlord or previous tenant has completed a basic cleaning of the premises, removing any trash, clutter, or unwanted items. However, it typically does not entail deep cleaning or extensive maintenance tasks beyond basic tidying.

“Broom Clean” is often used as a standard requirement in lease agreements or property handovers to ensure that the premises are left in an acceptable condition for the next occupant.

Tenants leasing a space described as “Broom Clean” can expect to find a clean and uncluttered environment, ready for them to move in and begin their occupancy without the need for additional cleaning or debris removal.

Generation Types

A commercial real estate premise described as “1st generation” indicates that the space has never been previously occupied. This term implies that the space is brand new and has never been used or customized by any prior tenants. 

A commercial real estate premise described as “2nd generation” indicates that the space has been previously occupied by one or more tenants. This term implies that the space has undergone previous tenant improvements, alterations, or modifications to suit the needs of the previous occupants.

NNNs (aka Triple Nets / Pro Rata Share Of CAM, Insurance and Taxes

NNNs, also known as Triple Nets, represent additional costs paid on top of the Base Rent. These cover expenses like Common Area Maintenance (CAM), property insurance, and taxes. Unlike Base Rent, NNNs are estimated and can change over time due to fluctuations in taxes, insurance, and maintenance costs. These expenses are usually calculated per square foot per year and can be converted to a monthly payment by multiplying by the size of the leased space and dividing by 12 months. For example, a quoted rate of $8 per square foot per year for 1,300 square feet would result in a monthly NNN payment of $866.67.

To calculate triple nets (NNNs), follow these steps:

  1. Identify the quoted rate: This is the dollar amount per square foot per year for NNNs, covering Common Area Maintenance (CAM), property and liability insurance, and property taxes.

  2. Determine the size of your space: Measure the square footage of the area you are leasing.

  3. Multiply the quoted rate by the size of your space: Multiply the quoted rate for NNNs by the square footage of your leased space.

  4. Divide by 12 months: Since the quoted rate is typically an annual amount, divide the result from step 3 by 12 to find the monthly NNN payment.

For example, if the quoted rate for NNNs is $8 per square foot per year and your leased space is 1,300 square feet:

NNN Payment = ($8/sq ft/yr) x 1,300 sq ft / 12 months = $866.67 per month

So, the monthly NNN payment for your lease would be $866.67.

The Reconciliation of NNNs is a process where the landlord adjusts the estimated expenses previously charged to the tenant for Common Area Maintenance (CAM), property insurance, and taxes.

At the end of the calendar year, the landlord calculates the actual expenses incurred and compares them to the estimated amounts collected from the tenant. If the tenant paid more than their fair share (overpaid), they will receive a refund or a credit toward future NNN rent. Conversely, if the tenant paid less than their fair share (underpaid), the landlord will issue invoices for the underpaid balance.

It’s important for tenants to be cautious of landlords who quote low estimated NNN amounts, as this can result in higher reconciled bills at the end of the year.

FAQ

  • A net lease requires the tenant to pay a portion or all of the property taxes, insurance, and maintenance costs in addition to rent. A gross lease includes these expenses in the rent, with the landlord covering the additional costs.
  • Commercial lease terms can vary widely, but common durations are 3, 5, or 10 years. The specific term often depends on the type of business and the landlord’s policies.
  • Common Area Maintenance (CAM) charges cover the cost of maintaining shared spaces within a commercial property. These charges are typically calculated based on the tenant’s pro-rata share of the total rentable square footage.
  • In a triple net lease, the tenant pays for property taxes, insurance, and maintenance, in addition to base rent. This type of lease shifts many financial responsibilities from the landlord to the tenant.
    • A lease escalation clause allows for periodic increases in rent, which can be fixed amounts, percentages, or tied to an index like the Consumer Price Index (CPI).
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  • A personal guarantee is a commitment by the business owner(s) to personally cover lease obligations if the business is unable to pay. This adds a level of security for the landlord.
  • Disputes are often resolved through mediation or arbitration, as specified in the lease agreement, before resorting to litigation.
  • Yes, lease terms are often negotiable. Commonly negotiable terms include rent amount, lease duration, rent escalation clauses, improvement allowances, and options for renewal or expansion.
    • Tenant improvements refer to modifications or build-outs a tenant makes to the leased space to suit their business needs. These can be paid for by the tenant, the landlord, or through a combination of both, depending on the lease agreement.
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  • Breaking a lease early typically involves penalties, such as paying remaining rent or a portion of it. Some leases may include a buyout clause specifying the cost of early termination.
  • Rent can be structured as a flat rate, percentage of sales (common in retail), or include scheduled increases (escalation clauses) over the term of the lease.
  • Responsibilities are usually outlined in the lease. In a gross lease, the landlord typically handles most maintenance and repairs. In a net lease, these responsibilities often fall to the tenant.
  • An exclusivity clause prevents the landlord from leasing space to direct competitors of the tenant within the same property or complex, protecting the tenant’s business interests.
  • Subleasing is generally allowed if specified in the lease agreement, but it usually requires landlord approval and can involve additional conditions or fees.