Commercial Real Estate: What Small Business Owners Need To Know
The commercial real estate market is vastly different from the residential market and much less standardized. Finding an available space can be a difficult task and the navigation of all the nuances of the market can be highly frustrating. Working with a commercial real estate broker that knows all the zoning restrictions and has connections to find you the right rental will allow you to focus on the important elements of your growing business.
Whether you are just starting your business or are moving your business out of your home, you’re most likely looking to lease a commercial space. This article gives you enough information to have the right conversation with a potential broker and attorney.
Don’t think you can afford a broker? The landlord usually pays their fee, so make sure you have that on your list of items for the negotiation.
Commercial Real Estate Terms
Before finding a commercial real estate broker, you should familiarize yourself with a few basic terms used in the industry. This will help you understand the language of commercial real estate and allow for an easier relationship with your broker and attorney.
Landlord: The owner of the commercial property.
Lessee: You and/ or your business, whichever is listed on the lease.
Triple Net Lease (NNN): A property lease whereby the lessee pays a fixed rental rate and the expenses on the property, including maintenance fees.
Gross Lease: A property lease whereby the landlord pays for all the property expenses. These usually include the utilities, taxes, and maintenance.
Percentage Lease: A property agreement whereby the lessee pays the landlord based on the sales volume generated at the property.
Tenant Improvements: These are interior improvements of the rental space. The lease will dictate who is in charge of the improvements, the landlord or the lessee.
Rentable Area or Rentable Square Feet: The physical walkable floor area within the property. It excludes holes in the floor like stairwells and elevators but includes restrooms, closets, corridors, etc.
Usable Area or Usable Square Feet: The measurements include the rentable area, plus any columns and recessed doors. Additionally, the shared common areas like restrooms and lobbies are partially included.
Common Area Factor: There are two types of common areas: building and floor. The building common areas are spaces in and around the building that are accessible by all of the tenants like the lobby. The charge for the building ranges from six to eight percent. Use of the floor common areas like bathrooms and corridors generally falls around eight percent. Typically a quote from the landlord includes a sum of the building and floor common areas, so in total this number can be from twelve to twenty percent.
Letter of Intent: An informal agreement between the landlord and lessee indicating their intent to move forward with negotiations. This letter can be helpful in a few ways, including completing a loan application.
Work Letter: An agreement between the landlord and a tenant regarding all the issues related to the tenant improvements.
Finding Your Broker & Attorney
It is important that you understand the difference between a leasing agent and a tenant broker. "If a business owner walks into the building directly, he's talking to the broker who represents the landlord. The broker's trying to get the best deal for the landlord, not for the tenant," says Howard Ecker, president and CEO of Howard Ecker + Company. Whereas a tenant broker works for you and will prioritize your needs and asks.
Tenant brokers generally prefer you to a sign a representation agreement, which gives them the exclusive right to represent you and show you properties. If you are renting a small space, a representation agreement is a good deal for you because it incentivizes the broker to find you the right space. However, if you are leasing a large space and the broker will receive a sizeable commission for finding the right space, you want to keep your options open and should consider not signing a representation agreement.
Commercial real estate brokers work on commission, which is a percentage of the lease. It’s in their best interest to find you the most expensive property. Which is why you may also want to hire a commercial real estate attorney. The attorney will have an incentive to negotiate the best deal for you and will be able to point out items in a lease that a real estate broker may overlook.
If you hire the real estate attorney first, they will know brokers that will assist you. If you are not hiring an attorney, see a referral from someone you know with a commercial lease. If you happen to live a small town where there is not a commercial real estate broker, then you will need to be your own broker.
Questions are so critical to making sure that you are paying what you expect and getting what is best for your business.
For instance, the utilities can be paid for by the landlord or the lessee. The utilities can also be paid off the meter or by square footage. When people talk about the "hidden fees" of commercial real estate, utilities
In the case of maintenance and repair, make sure you do your due diligence on everything that these items could cover and know whether you are responsible for them or not. Most commercial leases stipulate that the tenant is responsible for all property upkeeps and repairs which could include, lawns, trees, water fountains, awnings, bathrooms, carpets, etc. So, be sure that you know all of the elements that you may be responsible for fixing and maintaining.
Find out your exit options. Mostly you need to discover what will happen if you default and what the remedies might be if you do. Don't be blindly positive that your business will be successful. Statistically, your business is more likely to fail than succeed in the next five years. It is better to have coverage in your lease than to realize later that you needed to protect yourself and your business.
Navigating the Lease
Before you start negotiating a lease, don't stop looking until you find two or three rental areas that will work for your business. This gives you negotiating leverage.
Usually, the first lease you receive is completely skewed in favor of the landlord. They do this in hopes that you will sign it without understanding it. Remember, there is nothing standardized in the commercial real estate market and everything is up for negotiation. Ask for this lease as soon as possible and read it.
Start tracking the similarities and differences between the properties. Perhaps start a spreadsheet where you can track and compare the details. Some of those details should be rentable square footage, unit lease price, price per square foot, incremental expenses, and lease required expenses.
Unless you have been in business for a decade or more, a landlord will most likely ask for a personal guarantee. The landlord will want to run your personal credit, in addition to the business’ credit. They want to make sure that if your business fails for any reasons, you are personally responsible for fulfilling the obligation for the lease. These personal guarantees can have an expiration date. So, if you are asked to personally guarantee the lease, then ask for it to expire in two years.
The following are elements that may protect your business, but in most cases you will need to ask to add them to your lease.
Sublease: This clause will allow you to sublease your space to another business.
Exclusivity: Prevents the landlord from leasing the other spaces on the property to a direct competitor of your business.
Co-tenancy: If the property's anchor tenant closes, a co-tenancy agreement protects you from the loss of customers and allows you to break the lease if the landlord is unsuccessful in replacing the anchor tenant within a certain time frame.
Now that you know all that goes into a commercial lease, work with your commercial real estate broker to define the type of property you want for your business. Meet with your commercial real estate attorney to define the terms you want for your lease, then let them handle all of the negotiations. This is their expertise.
About S Wright
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