Understanding your business lease
When you sign a lease, remember that you are entering into a legal contract. You might want to consider obtaining legal advice before signing. The following information provides a good starting point for those unfamiliar with commercial leases.
Duration of your lease
Typically, a commercial lease will last anywhere from 3 to 10 years. It is important to determine when the lease begins and when the agreement will end.
Your lease should clearly outline what will happen if the rental space is not ready by the move-in date and what rent adjustments will be made by the landlord if it is not ready. Unless the space you agree to occupy is already vacant and remodelled to fit your needs, unexpected problems could occur.
Make sure you are aware of any clauses in the lease that allow the landlord to provide an alternative space if the new premises are not ready on time. This type of arrangement can mean that you might have to move your business more than once, which can increase moving costs.
If you are moving from an old location into new premises, give yourself extra time before leaving to cover any delays that could happen with the new location such as construction, tenants moving out or property damage.
Choosing a lease
Commercial rents are generally measured by the cost per square foot of the space. Many landlords charge tenants separately for heat and electricity. There are at least five common ways to calculate rent, including:
- Gross leases
Gross leases are the most common standard for office space and require you to pay a flat monthly amount. The landlord is responsible for all the expenses of operating the building, including taxes, insurance and repairs.
- Net leases
A net lease requires that you pay for some (or all) of the real estate taxes on the property, in addition to the base rent. Building operating costs are the responsibility of the landlord.
- Net-net leases
With a net-net lease, you are responsible for paying the base rent and taxes, as well as the insurance for the space you occupy.
- Net-net-net or "triple net" leases
Triple net leases pass on all of the costs of operating the building, including repairs and maintenance to the renter. These types of leases are usually used for industrial properties.
- Percentage leases
In a percentage lease, you pay a fixed rate plus a percentage of your gross income. Percentage leases are a special type of rental arrangement for retailers in multi-tenant locations such as malls or shopping centres.
In the past, the increasing cost of operating a building was covered by an increase in rent when the lease was renewed or when a new lease was created for a new tenant. Most landlords protect themselves from unpredictable changes in real estate by including an escalation clause in a lease agreement. This type of clause allows a landlord to raise the rent if the cost of maintaining or operating the property increases. Most landlords will negotiate the escalation clause with you.
Some examples of escalation clauses include:
- Regular increases in rent over the course of the lease
- Pro-rated increases in taxes, heat, maintenance and other direct costs
- Automatically raising the rent according to the Consumer Price Index (CPI) or some comparable index of inflation
Note: The CPI generally overstates the impact of inflation so you should not agree to pay more than a portion of the annual CPI increase, especially if the lease already contains increases for taxes and direct operating costs.
Sub-leasing your location
If you decide to expand your business or move locations before your lease ends, you can discuss sub-leasing with your landlord.
Make sure that the tenant who is interested in sub-leasing meets your landlord’s standards for the property. Keep in mind that you will be responsible for paying the rent if your sub-tenant decides to leave before the lease ends.
Renewing your lease
Once your lease expires, a landlord does not have a legal obligation to offer the same space to you unless you have agreed on a renewal formula and have a clause that guarantees the space when your lease expires.
You will usually have to provide written notice exercising your option to renew the lease, or it lapses automatically (a one-year notice for long-term leases is common, but three or four months can be the standard for short-term leases). Some leases are renewed automatically until you cancel them. This can be a good arrangement for your company if you have several locations and do not want to risk having your lease expire.
What happens if your landlord goes bankrupt?
You can protect yourself and your business by making sure that your lease contains a non-disturbance clause, which is an agreement that provides for the continuation of a lease in the event of loan foreclosure.
Generally, landlords are expected to carry a comprehensive insurance policy on their building that will cover liability for common areas (such as lobbies, stairways and elevators) and provides casualty protection for the building itself. Landlords also have the right to insist that tenants carry their own insurance to protect the landlord against claims that might arise from the conduct of their businesses (a visitor who trips on an office carpet, for example), as well as "contents and improvements" coverage that protects the landlord's investment in the property itself.
You may want to consult with a professional insurance agent or lawyer to make sure that your insurance policy works with your landlord’s policy.
Some of the points you will want to consider when negotiating the terms of your lease with your landlord include: electricity, HVAC and cleaning services.
- Electricity is often supplied as part of the building services. Ask your landlord if they will set limits if you plan to install electrical machinery.
- Heating, ventilation, and air conditioning (HVAC) are usually the landlord's responsibility. Commercial spaces rarely offer 24-hour HVAC service, so you can attach an HVAC schedule to the lease, and specify what services are to be provided on statutory holidays.
- Cleaning services should be on a formal schedule, and it is important to know who will be responsible for housekeeping details like cleaning restrooms and taking out the trash.
When you have reached an agreement with your landlord about the services that will be provided, make sure that you get the details in writing in the lease.
Modern office buildings generally provide allowances for improvements – such as new partitioning, lighting, carpets or paint – but there may be variations in individual tenant needs and what a landlord is willing to provide.
Agreements about renovations should be put in writing with a detailed plan and estimate of costs from a contractor before the lease is signed. This document is called a "work letter" and will specify who owns any improvements.
Unless you make an agreement in your lease, anything you add to the property belongs to the landlord when you leave the premises. Examples include air conditioners, light fixtures, shelving, cabinets, or manufacturing equipment.
Calculating square footage
Calculating square footage is a way to compare rents, but not all landlords measure square footage in the same way. Warehouse or factory space might rent for only a few dollars per square foot but a first-class office space or a desirable storefront usually has a much higher price.
When deciding on the size of your location, try to answer the following questions:
- How much usable space will you get for your money?
- How much of your rent is apportioned to "public" space such as lobbies, hallways, bathrooms and mechanical areas? (note that 25% - 30% is typical)
Now that you are familiar with the basics of a commercial lease, it may be useful to contact a lawyer that deals with real estate and business regulations for more information about your rights and responsibilities when signing a lease.
For more information on general business topics, contact Canada Business Ontario today. Telephone services are available in English or French.