It is important to understand the difference between different types of lease arrangements. Most commercial tenants will lease space under either a “gross” lease or a “net” lease situation.
Under a “gross lease”, the tenant pays a fixed rate of annual (or monthly) rent throughout the term of the lease. The landlord is responsible for paying the realty taxes for the property and all costs relating to insuring, maintaining and operating the project (these costs are included in the fixed rate of rent). For the tenant, the benefit of a gross lease is the absolute certainty as to how much total rent it will pay during the term regardless of any increase in realty taxes or operating costs.
A “net” lease is comprised of two rent components: (a) “Base Rent” – sometimes referred to as “Minimum Rent” – which is a specified dollar amount per square foot of the rentable area leased by the tenant (see below); and (b) Additional Rent which is generally the tenant’s proportionate share of realty taxes and operating costs payable by the landlord for the building, or complex which the leased premises are located. The definition of Operating Costs in the Lease should be carefully reviewed so that the Tenant understands, at least approximately, how much total rent it will pay. “Proportionate Share” is usually defined as a fraction where the numerator is the total square footage of the rentable area leased by the tenant and the denominator is the total square footage of rentable area of the complex. The intent of a net lease is that the “additional rent” component will reimburse the Landlord for all costs incurred by it in operating and maintaining the complex. Landlords tend to prefer net leases because they are able to recoup all costs associated with maintenance of the property from the tenant and also allocate all of the risks of any increases in such costs upon the tenant.
In addition to base rent and additional rent, some leases, especially in the retail and restaurant industries, will also allow landlords to charge “percentage rent” which is a percentage of the annual profits earned by the tenant from its operations from the leased premises.
In a “net” lease situation, because the annual amount that the tenant pays as base rent is based on the square footage of the rentable area of its premises, the tenant should require the landlord to have the premises measured by a qualified architect in accordance with generally accepted measurement standards (The Building Owners and Managers Association Standard (1996) is the prevailing standard for measuring office premises at the date of writing) and to provide the tenant with a copy of the measurements prior to the commencement of the lease term. This will ensure that the tenant is only paying rent on the actual rentable area of the space that is leasing. In the event that a measurement is not available before the lease is signed, the tenant should insist that the landlord complete the measurement within a reasonable period of time thereafter and retroactively adjust the base rent payable by the tenant if the square footage is less than expected. If the tenant has negotiating strength, and the landlord cannot deliver the measurements before the lease is signed, the tenant may be able to insert a clause in the Lease capping the number of square feet on which it pays rent regardless of the actual rentable area of the premises, particularly if the actual rentable area ends up being significantly larger than what the tenant had expected and budgeted for when signing the lease.
For a discussion of additional items relating to commercial leasing from the tenant’s perspective, please click here.
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