You’ve been a landlord working with the residential lease agreement for years, and now you’re ready to dip your toes into the commercial market. Leasing commercial spaces is a great way to diversify your portfolio and expand your investments.
While the business is similar to what you’re used to, the process comes with a whole new set of rules, regulations, and responsibilities. And it all begins with the commercial lease agreement.
Let’s take a closer look at the ins and outs of a commercial lease, including contract types, standard clauses and disclosures, what to include, and the benefits of using a free template.
Are written commercial lease agreements required?
If you’re renting out a commercial space for longer than 1 year, you can’t rely on a handshake deal or word-of-mouth agreement. Most states have a statute of frauds that requires owners to reduce the agreement to writing. The rule is simple: if your lease is longer than 1 year, you need to record it in writing.
However, most landlords rent out commercial spaces for 3 years or longer. In these cases, you almost always need a written agreement. And even if state law doesn’t require you to nail down the contract in writing because the lease term is shorter than 1 year, it’s a best practice to get it on paper.
By clearly outlining the details of your deal, you can avoid confusion, miscommunications, and legal disputes.
How does a commercial lease differ from a residential lease?
Before breaking into the commercial market, it’s crucial to understand how these contracts differ from the residential documents you’re used to. Here’s a quick overview of the main differences between the two agreements:
Contract length: While you usually rent out residential properties for 1 year at a time, commercial agreements are much longer. Generally, they range from 3 to 5 years.
Rent calculation method: Unlike residential pricing, which usually charges a flat monthly rent, commercial rental pricing is set by a per-square-foot rate. The typical rate depends on factors like property type, location, and the state of your local market.
Property owners have more authority: Commercial landlords usually have more control than residential landlords. For example, they can take actions such as enforcing evictions or removing tenants through arbitration. However, they’re not automatically responsible for repairs unless the lease limits their obligations under rent control laws.
Fewer regulations and requirements: Local laws heavily govern residential agreements, but commercial leases rely more on contract wording. Most terms are negotiable, so both parties need to keep a close eye out for vague phrasing or hidden meanings.
We recommend working with an experienced real estate lawyer in your local area to guide you through your first few commercial contracts.
Commercial Lease Types
Commercial real estate (CRE) has different contract structures based on how tenants pay rent. Here’s how they work:
Gross Lease
A gross lease bundles rent, operating costs, taxes, insurance, and utilities into a single payment.
It’s known as the most tenant-friendly option because there are no hidden costs, making it easier for occupants to budget their monthly and annual expenses. It’s also convenient for landlords, as it lets you predict your income without having to account for month-to-month changes.
Modified Gross Lease
A modified gross lease requires tenants to pay their base rent plus a share of the operating costs.
Property owners mostly use them for buildings with common areas shared by multiple tenants, such as a large office building with many businesses. These contracts usually include something called an “expense stop.” It states that the landlord will cover an expense up to a certain amount, and that the tenant must pay the remainder.
Net Lease
A net lease requires tenants to pay a base rent and the operating costs.
Operating costs can include insurance, utilities, maintenance, taxes, and more. There are four types of net leases:
Single Net Lease: Tenants pay base rent plus property taxes, while landlords cover operating expenses, repairs, and insurance premiums. It’s one of the least common contract types.
Double Net Lease: Tenants cover the base rent, insurance premiums, and property taxes. Landlords typically pay for operating expenses, maintenance, and structural repairs. Owners typically use them for multi-tenant properties.
Triple Net Lease: A tenant pays for the base rent, taxes, insurance premiums, utilities, and maintenance. Owners typically prefer them for large, single-business spaces.
Absolute Lease: Tenants cover all expenses, including the base rent, insurance premiums, taxes, utilities, and even major structural repairs. Owners typically use them for long-term single-tenant properties.
Percentage Lease
A percentage lease requires tenants to pay a base rent plus a percentage of the business’s gross income.
Landlords usually pay property taxes, insurance premiums, and maintenance costs. Both parties negotiate the percentage, and owners must clearly state it in the contract. Restaurants and retail stores commonly use a percentage lease, paying around 5%–10% of their profits to the property owner.
In summary, the type of lease you choose depends on the property type and the level of responsibility you’re looking for, amongst other circumstances. Always speak with a legal professional to determine the best course of action for your investments.
11 Common Commercial Lease Clauses and Disclosures
State and local laws require property owners to include many of these standard clauses in commercial leases:
1. Americans With Disabilities Act (ADA) Clause
The ADA requires all businesses open to the public to accommodate individuals with disabilities (Americans with Disabilities Act). In most cases, tenants are responsible for guaranteeing compliance. However, they may negotiate with landlords to have them provide elevators and other access features.
2. Competitor or Exclusivity Clause
When you include this clause in the lease, tenants can request that owners prohibit similar businesses from leasing in the building. For example, the owner of a pizza shop can ask the landlord to add a term stating that no other pizza restaurants can rent a space on the property.
3. Insurance Clause
The insurance clause outlines the responsibilities of both landlords and tenants. It specifies the types of insurance policies both parties must carry, as well as the required coverage amounts, liabilities, and limits.
4. Option to Purchase
Similar to a residential rent-to-own lease, an option to purchase in the lease allows tenants to buy the property after a predetermined period. Sometimes, both parties also set a price, but not always. If you include this clause in the lease, the tenant can indicate their intent to purchase the property, which will kick off a formal negotiation process.
5. Renovations and Repair Clause
If you don’t want to give a tenant free rein with the property, landlords can specify the improvements a tenant is allowed to make in the contract. The clause also identifies which party is responsible for fixing broken items and coordinating maintenance.
6. Termination Clause
A termination clause allows either party to exit the agreement. But most of the time, breaking the lease costs a significant fee. In most cases, tenants opt to break the lease and pay the fee if they’re going out of business. Landlords might face a penalty if they receive a reasonable offer to sell the building.
7. Rent Escalation
A rent increase clause outlines the rules for increasing the unit’s rent. Generally, the contract sets a certain percentage by which the owner can increase the rent every year or bases price adjustments on an external factor, such as the Consumer Price Index.
8. Lease Renewal
Commercial documents establish details for renewing the lease. It determines whether the lease will auto-renew or if both parties need to renegotiate. If it will automatically continue, the renewal clause defines the new lease term and rent price.
9. Use Clause
The use clause clearly states what occupants can do in the rental property. It helps protect the landlord by prohibiting activities that increase risk, violate local zoning laws, or negatively impact other tenants. They usually define permitted business types and prohibited activities.
10. Parking
If the property includes parking, the lease agreement will determine how tenants, employees, and customers can park. Mention any additional parking fees, specific rules, and restrictions.
11. Personal Guarantee
Suppose a business can’t cover its financial responsibilities, such as rent and other expenses outlined in the lease. In that case, this clause requires the tenant (usually the CEO) to pay the costs personally. Adding a personal guarantee protects landlords and keeps rental income running smoothly, even if the business you’re renting to can’t afford to pay the bill.
The above clauses are the most common, but there may be additional points you should add depending on the deal’s circumstances. As mentioned, it’s imperative to work with an experienced lawyer when drafting and reviewing a commercial lease.
What to Include in a Commercial Lease
In addition to the common clauses and disclosures we outlined above, commercial contracts typically cover the following:
Landlord, tenant, and property manager information: Include the names, phone numbers, and email addresses of all parties. Tenants should also include information about their legally formed business. Keep in mind that you can’t add a business entity that the state hasn’t formed yet to a lease.
Property details: State the full address, suite number, and square footage.
Length of the agreement: Define the start and end date, as well as an option to auto-renew (if applicable) and the rules for doing so.
Rent information: Outline how you calculated the rent amount, and clearly state the total rent amount, its due date, and any late rent penalties.
Security deposit: Set the amount tenants must pay as a deposit. Explain how you’ll hold the funds and the protocols for returning them upon the agreement’s end.
Utilities, insurance, and other expenses: Use your lease to specify the rules and responsibilities relating to additional costs. However, this will largely depend on the type of lease you choose.
Subletting clause: Explain the rules for subleasing. If the document doesn’t mention it, tenants typically have the right to sublet. However, tenants are usually liable if the subtenant doesn’t comply with the terms of the lease.
Arbitration: State that both parties must resolve disputes by adhering to an arbitrator’s decision.
Jurisdiction: Define which state’s laws will apply during a dispute. For example, it could be the state where the property is, or where the landlord lives.
Security: Determine who’s responsible for maintaining security systems, including cameras, alarm systems, and security guards.
Right of entry: Outline exactly when a landlord can enter the premises and how much advance notice they must give tenants.
Holdover tenancy: Use the lease to set financial penalties for tenants who stay past the contract’s expiration, and list the actions landlords can take to force them off the premises.
Advertising guidelines: Define the tenant’s rights to adjust signs, display advertising on the building, and update the marquee.
Solvency: State the tenant’s rights if the lender forecloses on the property.
Zoning: Mention the zoning laws or other legal restrictions tenants must abide by.
Eviction process: Explain the legal grounds for evictions and outline the process for both landlords and tenants.
By including these essential items, your contract will clearly outline everyone’s rights and responsibilities. It’s the first step to preventing disputes and keeping your investment property in good, legal order.
Do commercial leases need to be notarized?
Most states don’t require landlords or tenants to have a commercial contract notarized, but some states do. For example, Ohio requires it for all leases longer than 3 years (Ohio Rev. Code § 5301.08).
However, many landlords and tenants prefer to take this extra step even when their local law doesn’t require it. Getting the document notarized helps to confirm its validity and prevent miscommunications if disputes arise down the line.
Use a Free Commercial Lease Agreement Template
We hope this guide has helped you get started with commercial leases and set you up for a successful business venture.
Instead of drafting your own contract, we recommend using our free PDF template. It’s printable and customizable, so you can quickly fill in the information you need. Top landlords use free templates to ensure they cover all the essential points with proper verbiage that protects their investments.
Download the template at the top of this article now, and don’t forget to have a legal professional review the finished documents before you sign. Good luck with your commercial real estate ventures!
