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A commercial lease where the tenant pays base rent plus pays for its pro rata share of some or all operating expenses related to the tenant’s occupancy of the space. Types of net leases include single net, double net, triple net, and absolute triple net. Expenses may be billed directly to the tenant, or the expenses may be paid by the landlord and reimbursed by the tenant. Net leases contrast with Gross Leases, wherein the landlord pays for all operating expenses.
Single Net (N): a net lease where the tenant pays base rent plus pays for one of the operating expense items such as common area maintenance (CAM), insurance, or property taxes
Double Net (NN): a net lease where the tenant pays base rent plus pays for property insurance and property taxes
Triple Net (NNN): a net lease where the tenant pays base rent plus pays for all operating expenses
Absolute Triple Net: a type of triple net lease where the tenant pays base rent, all operating expenses, plus pays a portion or all of the capital expenditures to maintain the condition property
Gross Lease: a type of Lease where the tenant pays rent all-inclusive of operating expenses.
Common area maintenance is one of the three main components that make up operating expenses, the other two being insurance and property taxes. This, in turn, makes CAM part of what is called a Triple Net (NNN) Lease.
Common Area Maintenance (CAM) expenses are fees paid by tenants to landlords to help cover costs associated with overhead and operating expenses for common areas. Common areas are spaces used for or benefited by all tenants and include, but are not limited to, hallways, elevators, parking lots, lobbies, public bathrooms, and building security.
CAM expenses are usually defined in the lease to clear up any ambiguity as to what they entail. It is important to have a clear understanding of these expenses before signing a new lease.
Total Annual CAM Expense = (Tenant Rentable Square Footage)/(Total Rentable Area of the Building) * Estimate CAM for the property.
This total expense is calculated into your monthly operating expense so that it can be paid in small increments throughout the year.
At the end of the year, the property manager will reconcile actual CAM expenses with the estimated cost. If the actual CAM expenses are less than the estimated, the property managers will issue you and the other tenants a credit for the difference. If the estimated CAM did not cover the actual costs for the year; however, you will owe this difference as a lump sum.
Operating expenses are the costs associated with operating and maintaining a commercial property such as an office building or retail centre.
In a multi-tenant building, each tenant typically pays their pro rata share of operating expenses based on the size of their space relative to the building, whereas, in a single-tenant building, the tenant is typically responsible for 100% of total operating expenses.
Operating expenses are made up of three main components:
Operating expenses should not include debt service, CAPEX, property marketing costs, capital reserves for future large repair projects, leasing commissions, or tenant improvements allowances.
Typically, the property tax and insurance components of operating expenses are not negotiable. These items are considered uncontrollable, and, therefore, they are passed directly through to the tenant.
Controllable expenses, such as CAM expenses, are negotiable to some degree as landlords and property managers can control how efficiently a building is being managed. Negotiating a cap on annual operating expense escalations is the most common form of tenant protection.
The Gross up provision stipulates that if a building has a significant vacancy, the landlord can estimate what the variable operating expense would have been had the building been fully occupied, and charge the tenants their pro rata share of that cost.
The gross-up provision only applies to variable expenses, because these are incurred directly as a result of the tenant(s) occupying the building.
Fixed expenses are not a part of the gross-up, because the costs remain the same with or without tenants, and the landlord is obligated to pay those expenses regardless of the building’s occupancy.
Advantage of Gross-up to both the parties:
Landlord: A gross-up provision allows the landlord to preserve his income stream and cover the actual costs to operate the property despite below-average occupancy.
First, it allows for predictable budgeting. Without a gross-up provision, operating expenses could vary drastically year to year, making predicting annual real estate expenses a nightmare.
Second, if operating expenses are based on a base year, the gross-up provision can protect the tenant from a big spike in their share of operating expenses.
A tenant improvement allowance (TIA) is money given from a landlord to a tenant to help pay for the improvements to office space, or sometimes other expenses associated with moving into a new space. The specific amount of this allowance is negotiated into the lease, along with a detailed outline of what it can be spent on.
Depending upon the lease, TIA may have restrictions on where it can be applied. Landlords will usually allow TI to be spent on the hard costs and soft costs of the project.
Hard costs like:
Soft costs such as Construction Management Fees.
Exclusions may include:
Please note tenant may be able to use the unused portion towards the rent as well if negotiated in a lease.
Tenant Improvement Allowance (TIA) can be structured either as a part of rental rate, or as an amortized loan from a Landlord.
A security deposit is a payment a tenant makes to the landlord before the lease begins. This payment may or may not go towards rent, but also can be held by the landlord as “security” against future unknowns that may occur during the lease term. Most often the deposit is used after you move out of the space to repair any damage that may have occurred before the new tenant occupies the space.
The deposit is refundable, and it cannot be used to repair normal wear and tear. So if no major damage occurred during your lease, and you consistently pay your rent on time, you will likely be refunded the entire deposit within 30 days of your move-out.
The landlord calculates Security as the number of months of rent, typically from 3 to 6 months.
A lease guarantee is an official agreement signed by the landlord, tenant, and in addition, a third party (eg. Corporations, Banks, or an Individual) who meets the monetary requirements of the landlord. A lease guarantor serves as a financial intermediary and is responsible for the tenant’s defaults, which protects the tenant from eviction.
The purpose of a lease guarantee is to provide protection for both the landlord and tenant. If a tenant does not meet a landlord’s credit requirements, the landlord may propose a lease guarantee, which should be mutually beneficial if negotiated correctly.
Permitted Use is the use of the property as mutually agreed between the parties. Example: Office, retail, restaurant, etc.
Parties can also negotiate the Exclusivity clause in a lease, which restricts the Landlord to rent out space to other tenants in the same business.
Most leases require you to continuously operate your business while you are leasing space in the property and if you violate your centre’s hours of operation or close down completely, you could end up in default. A go-dark clause gives you the opportunity to shut down your operation without sanction from the landlord as long as you continue paying your rent.
Assignment: An assignment is the transfer of the party’s entire interest in a lease. When a tenant assigns its lease, the assignee takes over the tenant’s obligations under the lease and deals directly with the landlord.
Sublease: A sublease is the transfer of all or a portion of the premises for less than the entire term of the lease. A transfer of all of a tenant’s space for a term that is 1-day less than the lease term qualifies as a sublease
The signage clause is another most negotiated clause in both office & retail buildings leases. It gives a right to display Tenant company signage on the most prominent spot which can be visible to their prospects and clients. Signage rights can be on interior or exterior. For an office building, sometimes exterior signage is only allowed or negotiated with the tenant occupying the largest rentable square footage in the building.
Signage display is subject to the landlord’s approval.
A “default” is a failure to comply with a provision in the lease. A common example is a failure to pay the rent on time. Failing to meet any of the requirements in a lease can legally constitute default, e.g., not showing evidence of insurance, removing trees is prohibited by the lease, not repairing a structure.
Default clause should be reciprocal, landlord-friendly leases often forget to add the clause related to the Landlord Default. The Tenant is in default if not paying rent on time or not performing their covenants as per the lease, but what are the Tenant remedies if Landlord does not perform their covenant and services as per the lease. Therefore, it is highly recommended to negotiate Tenant remedies in the lease if the Landlord is in default.
A holdover clause simply states that if/not a tenant remains after the lease expires, if it does, then the tenancy becomes month-to-month with the increased rental rate.
A subordination clause is a clause in an agreement that states that the current claim on any debts will take priority over any other claims formed in other agreements made in the future. Subordination is the act of yielding priority.
When a property is being leased, it can be common for the tenant to invest a certain amount of money in leasehold improvements or to rely on the possession of the property until the expiration of the lease term. If the owner of the property defaults on the mortgage, the tenant can face serious inconveniences, if not real losses. The lender can have the tenant evicted even if the latter respected his or her contract obligations. In order to avoid this situation, a tenant’s best solution, if possible, is signing an agreement with the lender in which the lease is given priority over the mortgage.
Sample Subordination Agreement
A clause in a contract stating that certain facts are true as of the date the contract is signed. For example, the estoppel clause may state the collateral or amount of a loan. It is put in a contract to eliminate any ambiguity.
The purpose of an estoppel statement is twofold: (1) to give a prospective purchaser or lender information about the lease and the leased premises and (2) to give assurance to the purchaser or lender that the lessee at a later date will not make claims that are inconsistent with the statements contained in the Lease.
Sample Estoppel Certificate
You often see clauses such as Indemnity, Defaults, Damages, and others use a language where parties are responsible for the defaults resulting due to their “Negligence”. Sometimes, parties use the word “Gross Negligence” and reviewers may ignore the word “Gross” which may have greater implications if it comes to proving “Gross Negligence” compared to the “Negligence”.
Let’s first understand the difference between Negligence and Gross Negligence.
Negligence: It is an act of carelessness.
Example: Landlord security system failure that resulted in theft is considered to be negligence on behalf of the Landlord and Tenant may easily claim damages. However, it is difficult to prove that the Landlord willfully failed or did not repair the security system on time which resulted in a theft.
Gross Negligence: It is a “wilful” or an “intentional” act that resulted in carelessness on behalf of the Parties.
Example: Landlord security system failure that resulted in theft is considered Gross Negligence if Landlord received several notices to repair the system but did not take any action to remedy the correct.
This is again difficult to prove in court as Landlord can challenge stating that they were working on rectifying the issues. Therefore, it is advisable not to use the word “Gross Negligence”.
However, the party drafting the lease agreement sometimes acts smart and uses Gross Negligence for themselves but Negligence for the other party. It is recommended to use the word “negligence” only or be reciprocal and use the same keyword for both parties.
Critical dates are very important when tracking information in lease administration software. Dates related to Expiration’s, Early Terminations, and Renewals are common to track, what is likely to be missed or normally Tenants tend to forget is the date by which
1) Tenant Improvement Allowance (TIA) has to be collected;
2) Caveats or Registration has to be filed;
3) Landlord default notice to be triggered if Landlord is in default;
4) Rent Review is pending;
5) CAM reconciliation is due;
6) Also any random payment including security deposits to be collected from the landlord;
7) Insurance renewal is due;
8) If any Guarantees or Letter of credit need to be renewed or cancelled, etc.
The termination option is a right given to either party to terminate the lease earlier than it expires. This is the most important option that provides flexibility to exit if the business is suffering losses and the tenant wants the right size. Also, it is although not in the best interest of the Landlord they do negotiate to let the Tenant terminate early by paying a penalty equivalent to the negotiate months of rent.
Expansion Option: An expansion clause is something that can be negotiated into a commercial real estate lease that allows the tenant guaranteed or preferential rights to expand within the building or portfolio from which they are leasing.
Right of First Refusal (ROFR): A ROFR is commonly triggered when a property owner receives an acceptable offer to lease from a third party. Prior to accepting the third party offer, the property owner must allow the holder of the ROFR to either lease the subject property either upon the same terms and conditions contained in the third party offer or upon terms otherwise specified in the parties’ ROFR agreement. The owner may only proceed with leasing the property to the third party if the holder of the ROFR does not timely exercise its right to purchase or lease the property.
Right of First Option (ROFO): A ROFO is commonly triggered when a property owner elects to make his or her property available for lease. The property owner must “first offer” to lease the subject property to the holder of the ROFO on terms and conditions that are determined by the owner. If the holder of the ROFO does not timely exercise its right to lease the property, the property owner may proceed to offer the subject property for lease to third parties.