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How Commercial Leases Work: An Intro

A commercial real estate lease is an agreement that allows a business to rent commercial property from a landlord. Want to know how it works, and what types there are?

Hello everybody. Have you ever wondered how commercial leases work? You know, square foot per year? Square foot per month? Gross lease percentage rent? Triple net? Hmm… Kind of scratching your head now, aren't you? Well, you've come to the right place because I am going to explain it to you.

My name is Dedy Tando with Austin 101 Realty. Welcome to our blog where we talk about all things real estate here in Austin, Texas. Austin 101 Realty has helped hundreds of investors grow profitable portfolio here in Austin and we have tips for getting the best out of your money and so much more.

So when you rent a house or an apartment(residential), you typically see the price quoted as per month. That will cover everything. You don't have to worry about paying extra for taxes, insurance, or maintenance. So typically for one bedroom, one bath, it might be a thousand square foot and it's quoted as maybe a 1100 to maybe 1200 per month. And for two bedroom, two bath could be 1500 per month, 1800 per month. But you don't have to worry about whether paying taxes, insurance, and all that.

However, in commercial real estate it's a little bit different. First, calculate based on the square footage what the total rent is. So a lot of times, for example, for a thousand square foot office, the rent could be $24 per square foot per year. Then you would take that $24 per square foot multiplied by a thousand and then divided by 12 to get your per month rent. Now if that per month rent is all that you pay that in commercial real estate terms will be a gross lease, which means it covers everything. You don't have to worry about paying extra. Nevertheless, very commonly seen in commercial real estate is a triple net lease, which means that the taxes, insurance, and maintenance are separate from the base rent. You have base rent and you have the triple net, which is basically the taxes, insurance and maintenance. 

How these two parts work is like this: the base rent can increase every year according to a certain percentage or a certain amount. But, the triple net part of the rent then goes up and down according to how much the taxes, insurance, and maintenance total allowed to be every year. Besides the gross lease, sometimes you may have the added benefit of the landlord covering electric or water for and and or trash collection for you. And if one of these utilities is covered by the landlord, whether by design or maybe by default you happen to rent an office space in a condo, the condo association covers the water and the trash collection. These kind of lease will be called the modified gross. So basically you pay a full gross lease amount, which also already covers that particular utility. 

Now, if all of the utilities are covered, it's called a full service gross. These kind of situations are a little bit more rare but also not so uncommon, especially when you have owners that occupy a part of the building and then rent out the rest of the building to the tenants. It's easier for the owner to charge a full service gross then to try to separate out right and charge back the utilities to the tenants. 

Then you have another type of lease which charges the at tenant in addition to a triple net amount, it charges a percentage rent based on the amount of sales that the business makes. A lot of times when you find this in retail situations where a store maybe does very little business in the beginning but has the potential to increase the business and landlords typically want to take advantage of this. But not only that, of course with more customers and more business, there is more wear and tear in the building. That makes it understandable that landlords will want to charge this percentage rent. They set these percentage rent at at a break point for business that earns $3 million a month and landlord may want to set the break point at $2 million. Anything that the tenant earns above $2 million, they have to pay a certain percentage of that over income amount and pay that as a monthly rent to the landlord. 

Where do you find triple net and gross lease?

Well, triple net is one of the most common lease structure amongst all of the commercial real estate. Basically it can be applied almost anywhere. Gross lease on the other hand, that's very common in multi-family landlords renting out to tenants and charge them per month for two bedroom, two bath or one bedroom and bath there. 

There may be some additional income coming in, for example,  from the tenants using the laundry facilities. Those will not be part of the lease which are just amenities that the landlord provides and from that benefit, the landlord also earns extra income. 

Now that you know more about how commercial real estate leases work now, do you feel more confident as a tenant to approach your landlord and try to negotiate certain terms more in a favor? Or as a landlord, do you feel like there are opportunities that you can take to increase your cash flow? 

Please comment below. 

Let us know what you think and feel free to post us any questions that you may have and be sure to download our free investment guide below, which tells you all of our tips and tricks for investing in the Austin area. Thank you very much and have a wonderful day.