Commercial Leases for Franchisors and Franchisees
An Introduction to Commercial Leasing Concepts
If you are a business owner considering leasing space for a retail location, an office or any other commercial purpose, you would be well-advised to retain an experienced real estate attorney to assist you. If you are in the preliminary stages of such a process, perhaps already speaking with a commercial real estate broker, then you may have heard some phrases or terms you are not familiar with. This blog is intended to ease you through the initial investigatory stages of leasing commercial space by explaining some of those terms.
Triple Net (NNN) Lease vs. Gross Lease:
Leases fall generally into two categories, with some variations: a net (often “triple net” or “NNN”) lease, where the rent payment is net of some or all of the expenses associated with the property, or a gross lease, where a tenant pays rent only and the landlord is responsible for other property expenses.
Most net leases follow a triple net (NNN) format. The term “triple net” refers to the broad categories of real estate taxes, insurance and maintenance. In other words, the rent to landlord is all net profit.
In a gross lease, the tenant simply covers rent. Because of this, a gross lease calculation will frequently be a higher rent amount, since the landlord will then have to pay a property’s expenses after receiving the rent. Office leases and unit retail leases (that is, part of a building shared with other operators) are typically not net leases, unless all or a substantial part of a building is being rented; these leases usually have clauses passing on additional charges for operating or maintenance expenses, increases in real estate taxes and insurance charges.
Assigning, Subletting, or Terminating a Commercial Lease:
A lease for office or retail use will have provisions governing the tenant’s ability to sublet a portion or all of the premises to another user and to assign the lease to another user. These provisions are important to a tenant because business conditions or financial considerations may cause a tenant to decide prior to the end of the term that the space is no longer ideal for its original purpose, simply too expensive, or the tenant may be interested in selling its business (which will require the conveyance of the lease).
Assignment or subletting is typically the only recourse for a lease that no longer works financially. Since leases do not contain tenant termination provisions, if a tenant should walk away from a lease prior to the end of the term, a landlord can sue for the rent due for the entire term. If personal guarantees have been given by the tenant, this can present a substantial personal liability.
Many leases simply state assignments and sublets are not permitted or are only permitted with landlord’s consent, without conditions. The tenant will then have to request consent and accept any conditions that a landlord wishes to impose before consenting, or they may simply be turned down. It is crucial in the initial lease negotiation that the tenant’s representative push in favor of clauses that permit sublets to qualified sublessees, or an assignment with consent not to be ‘unreasonably withheld’ or a permitted assignment to a qualified tenant (such as one with similar financial qualifications), particularly in connection with the sale of the business. Without such clauses, the tenant is at the landlord’s mercy when the need for an assignment or sublet arises.
Next blog: Insurance provisions; real estate taxes; operating expenses and common area maintenance (CAM); initial construction, landlord contribution and free rent.