Types of Commercial Leases-What’s in a Name?

There are as many types of commercial leases as there are creative lawyers to draft them. Most types of leases are defined either by the kind of property involved (industrial, retail, office), or by how the rent is calculated and who pays what.

Industrial/Office/Retail Leases. While industrial, retail and office lease forms will contain many similar provisions, “one size does not fit all”. In a retail lease for example (especially in large shopping centers), the following provisions can be found that are not often utilized in office and industrial leases: a) Continuous Operation (the tenant is required to open and operate their business on the premises, continually, throughout the lease term); b) Exclusive Use (the tenant is granted the exclusive use to operate a particular business in the shopping center); c) Radius Restriction (the tenant is required to covenant that it will not lease space within a radius of so many miles of its leased premises for the same use [e.g., a second pizza hut location too close to the one which is the subject of the lease]; d) Percentage Rent (the tenant is responsible for paying base rent on the property, as well as a monthly percentage of income earned from the business occupying the leased space); and e) Co-Tenancy (the tenant reserves the right to terminate the lease, or pay lower rent if an anchor tenant leaves the shopping center).

In an office lease, there are typically more services provided (e.g. elevator, janitorial, guard/concierge) by the landlord (which expenses are typically passed on to the Tenant). In addition, the concept of “usable” vs.” rentable” square footage and “load factors” must be understood and evaluated. A Load Factor is a method of calculating total rent of a tenant that combines usable square feet of the premises and a percentage of square feet of common areas. Basically, usable square feet + percentage of common area square feet (for common restrooms, lobby, elevators, stairwells, and hallways) = rentable square feet. This calculation of the addition of a percentage of the common area expenses to monthly base rent is known is the "load factor." In order to simplify and standardize the measurement of office space, the Building Owners and Managers Association International ("BOMA") has adopted uniform standards for the measurement and leasing of office space. The "BOMA Standard" is utilized in many office leases.

In industrial leases, particular attention should be given to the availability of “industrial amenities” (e.g. high pressure gas lines; cranes; truck docks and “drive-ins” and electrical capacity) and environmental provisions in the lease. Representations, warranties, covenants and indemnities are the norm for the tenant and its operations, as well as regarding landlord’s common area operations and past environmental status of the premises. An environmental audit is often recommended so that a “snapshot of environmental status” can be taken at the lease’s inception.

Lease Types based on Rent-Gross vs. Net Leases. Typically, when dealing with commercial real estate leases, a gross or net lease is utilized, with net leases coming in more than one “flavor”. The following summarizes the basic types and their variations on a theme.

In a gross lease – aka a “full service lease”, the landlord pays all of the expenses associated with maintaining and operating its property (such as insurance, taxes, repairs, trash collection…). These costs will be blended with the base rent to determine the overall rent due by the tenants. Gross lease provisions are usually used for industrial/warehouse space, but can be found in office and retail leases as well. The term “Modified Gross Lease” (sometimes referred to as an “Industrial Gross Lease”) describes a lease in which some, but not all operating expenses are absorbed by the Landlord.

A “net lease” requires the tenant to pay, in addition to rent, some or all of the property expenses that normally would be paid by landlord (or "lessor"). These include expenses such as real estate taxes, insurance, maintenance, repairs, utilities, and other items. For “multi-tenant” properties, such as a shopping center, the expenses that are "passed through" to the tenants are usually pro-rated among the tenants based on the square footage of the area leased by each tenant. The tenant’s share of expenses is often referred to as “Tenant’s Proportionate Share”. There are different kinds of “net leases”, with different names to describe same based on what market one is in, and who is describing the lease (e.g., tenant, landlord, broker or attorney) Many in the commercial real estate industry describe the variations of net leases as follows:

Single Net Lease - the tenant pays for real estate taxes as well as the base rent.

Double Net Lease - the tenant pays for real estate taxes and commercial property insurance.

Triple Net Lease (or Net-Net-Net or NNN) – the tenant pays all real estate taxes, building insurance, and costs associated with the repair and maintenance of any common areas. This form of lease is most frequently used for single tenant buildings and retail space.

Absolute Triple Net lease (or "True Triple Net Lease”)- in the so-called “true” triple net or “bondable” lease, tenants will pay (or reimburse landlord for), in addition to real estate taxes, insurance and common area maintenance, their proportionate share of roof replacement and structural costs to the building. Typically, these leases are not terminable by the tenant, nor are rent abatements allowed. Basically, the tenant pays for and assumes every imaginable real estate risk related to the property.

But what’s in a name? As you might expect, there is much disagreement among landlords, tenants, brokers and attorneys re: the type of lease they have. Focusing on the “label,” however is misguided and problematic. Closely analyzing the lease to determine who is responsible to pay for what is much more important, especially regarding the scope of a tenant’s and landlord’s respective liabilities under commercial leases for repairs and replacements.

When allocating responsibility for maintenance and repairs, most commercial landlords intend for their tenant to make most of the repairs, or be responsible to reimburse the Landlord for same. Does repair mean replacement? Some landlords may think so, however, most courts have decided that if a landlord wants a tenant to replace the roof, for example, vs. patch it periodically, the lease must provide, to the effect, that “it shall be the tenant’s obligation to repair and replace the roof.” See ASP Properties Group v. Fard, 35 Cal Rptr 3d 343 (Court of Appeals, 2005). See also Robert A. Schoshinski, America Law of Landlord and Tenant, §5:18 at 271 (1980). In the ASP case, a lease amendment was prepared after the lease was signed, to add the roof to the list of items that the tenant was to repair and maintain in good and safe condition. However, the Court determined the list to be a list of repair obligations, not replacement obligations for the tenant. Simply stated, “the courts have held that an express covenant to repair will not be enlarged by [language] construction…a covenant to repair does not include a covenant to replace”. Ohio Real Property Law and Practice, Sec. 20.08 [1]-[3] (2007).

The moral of today’s lesson? Don’t worry so much about what you call the lease; make sure you know what it says, and that your intent, especially regards who pays for what and who makes repairs and./or replacements is clearly spelled out. In other words, "watch your language" and “Say what you mean, precisely, or a judge will decide what you meant.”

1 comment :

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