By David Marino
Commercial real estate leases are packed with terms and concepts that can catch even the savviest executives off guard. From hidden costs buried in rent structures to overlooked clauses that create real financial risk, understanding the language of leasing is essential. This can serve as a guide, breaking down key terms every business leader should know so you can engage with confidence and clarity.
1. Rentable Square Footage vs. Usable Square Footage
The usable square footage is the space within your own specified premises. It includes the surface area of the space, whether there is a wall on top or a column, to the exterior surface of the windows, to the exterior surface of any demising wall between your space and a common area, and to the midpoint of any shared demising wall with another tenant—landlords get you for every inch. The rentable square footage adds your share of the building common areas to the usable square footage. Common areas may include building lobbies, amenity areas such as gyms and conference rooms, and electrical rooms and the main point of entry. The rentable square footage also includes your share of the floor common areas, including restrooms, fire corridors, elevator lobbies, IT rooms and janitorial closets. For a typical full floor tenant, your “gross up” from usable square footage to rentable ranges from 6% to 10% of additional common area space. For a multi-tenant floor, the conversion from usable square footage to rental square footage can be anywhere from 15% to 25% depending on the nature of the building. The same is true for biotech wet lab buildings, except the core factor can be much larger as landlords are liberally entitled to allow other utility areas into their common space, so the conversion from usable square footage to rentable may be even a higher percentage.
2. Different Types Of Rent Structures: Triple Net (NNN), Net Of Electricity and Full Service Gross
This is an area that will trip up many executives as these terms get thrown around as if everybody should understand what they are. The biggest challenge that an executive has is adjusting the rent to compare apples-to-apples. A triple net (NNN) rent is conventionally seen in industrial buildings, biotech lab buildings and very occasionally in office buildings. The “NNN” means that the rent is exclusive of three things, which are categorically called the “operating expenses” (sometimes casually referred to as “the triple nets”) which are the cumulative cost of the 1) real estate taxes, 2) real estate damage and destruction insurance, and 3) other common area maintenance (CAM) costs such as water, property management fees, landscaping, elevator service agreements, and building repairs and maintenance. With these NNN form of leases, the tenant is responsible for their own janitorial within the premises, their own electricity and certain repairs and maintenance responsibilities in the space, which could include maintenance of the HVAC systems in an industrial building. In some sale-leaseback leases, the tenant is further responsible for all capital and structural repairs and replacements, which can create increased risk and cost for the tenant.
The second most common form of lease is “net of electricity” in office leases, or “industrial gross” leases in industrial settings. These leases in office buildings include all of the operating expenses and janitorial services, but the tenant is separately responsible for electricity service to the premises. In industrial buildings, this form of industrial gross lease typically includes the operating expenses within the rent, but not janitorial, electricity and maintenance responsibilities.
Full service gross is a term used in mid-rise to high-rise office buildings where the landlord simply pays all of the expenses, including janitorial and electricity, and the tenant pays a rent that includes all of these expenses. This rent is subject to a pass-through called a “base year,” which refers to the incremental increase in these expenses each year of the leas, above the “base”—typically the year in which the lease begins. While the landlord pays all of the expenses for the building out of the rent, the tenants in the building are responsible for the escalation of those same expenses during their respective terms. Executives are often fearful of these operating expenses as there’s very little control and predictability, but for smaller leases for a short term, they are not material. Once a tenant becomes over 10,000 SF and their lease term is over three years, it’s important to understand the incremental impact of these expenses over the term.
Business leaders can make a mistake in their financial analysis by not understanding the difference between these lease structures, and every building will have different operating expenses. When comparing those apples-to-apples, the right advisor can extract these future expense budgets from the landlord so that a proper financial analysis can be built, but understanding the gaps between the different structures is particularly important for an executive.
3. “Use By” Dates On Tenant Improvement Allowances
Tenant improvement allowances are common concessions, both in new leases and renewals, but landlords create a trap door in the lease document where if you do not provide notice to get reimbursement of the allowance by a certain terminal date, the rights to the allowance lapse. Many a leader has been stung by getting a great deal negotiated, and then neither they nor their broker tracks this date—the value evaporates.
4. Turnkey Tenant Improvement Allowances
Be careful of a landlord and their broker trying to make it look like they will pay for everything you want by offering to do a “turnkey” tenant improvement project. When you read the lease fine print, you will find that the tenant turnkey allowance is subject to some kind of cap, or subject to some kind of plan attached to the lease. However, more often than not, the corporate tenant is not savvy at developing architectural plans, detailed drawings and specifications, whereby often floor covering, lighting fixtures, electrical requirements, specialized HVAC, upgraded finishes and other details are not fully documented in the plan, and thus the landlord has no intention of paying for them. You wanted a refrigerator and dishwasher with that space? If it was not on the plan, it is your money that you will be spending.
5. Commencement Date Risk
For an executive that does not understand how long it will take to prepare the premises or complete the tenant improvements, the risk of the lease commencing before the premises are prepared for occupancy is high. Landlords will often bargain for a fixed commencement date, or some kind of outside commencement date as part of their negotiations, which gets incorporated into the lease. Often several months lapse from the beginning of the negotiations to when the lease is signed, and with the passing of time, the commencement date negotiated months before does not give the tenant adequate time to prepare the premises for their occupancy. In addition, delays in completing plans, or with city approval and vendor selection, can further delay the process whereby commencement can offer occur before the work is complete for you to move in.
6. “As-Is” Condition
Unlike buying a home in most states where the homeowner has a legal obligation to disclose all known conditions, commercial real estate is much more of the wild west. Many landlords and their brokers do not reveal known facts, and more often do not even know the facts as it relates to the space due to the lack of documentation and the lack of being hands-on with the property. Simple questions as to whether the air conditioning systems are in good operating condition are often not known by the landlord or their broker. Landlords rarely do any kind of ADA survey or property inspection, where they know what they are handing over the tenant, so the lease often gets negotiated with the premises being delivered “as is” where you spend your tenant improvement allowance fixing up everything. Often, issues of obsolescence, code compliance and other problems only reveal themselves during the construction process itself, and usually cannot be discovered with a simple visual inspection before lease execution. It’s imperative to protect your company by ensuring that there is thorough language in the negotiations, and ultimately in the lease, where all building systems shall be in good working order and all fixtures in good cosmetic condition, so that the expenses to remedy do not come out of the limited tenant improvement allowance.
7. Lease Assignment
An executive that is considering mergers and acquisitions, as well as the raising of capital or going public, needs to ensure that the term sheet is negotiated so that the company can freely sell stock and equity in the company to raise money without such an event being deemed an assignment, regardless of the percentage of the company’s equity that is sold. In the event you are selling the company to an acquirer, the sooner that you can provide notice to the landlord with the financial and business information that they will require, the better. Often attorneys deal with this during the final closing of the sale of the company, and it becomes one of those issues that creates last-minute delays. As an executive, you cannot allow that to happen and need to ensure there is language in the lease to allow for such transfers without consent, or get well ahead of the process with the landlord to bring them into the conversation early during the M&A process.
