How to Negotiate a Commercial Lease


Steve Freeman: I’m sitting with Steve Katkov of Thompson Hall. So even though there are more protections in a residential lease, there probably needs to be much more protection in a commercial lease because that can have a larger impact on the finances of an owner. Isn’t that right?

Steve Katkov: Absolutely. And the goal of all good commercial lease negotiation should be to manage the financial understandings of the parties, because commercial leasing is generally done in America on a net lease basis. And let me explain what I mean by that. The landlord has a large investment of time, energy, and money in developing a property for lease. Part of his compensation, or if you will, the return on his investment, we can characterize as base rent. Think of that as the price you pay the landlord for the privilege to conduct business from his building. So that’s an essential part of his benefit and return on his investment. But also, it cost the landlord a fair amount of money to have you make use of his space. And those expenses are largely passed on to you as the tenant. Those we can characterize as additional rent, base rent being the benefit of his bargain, the right you get or privilege to operate out of his space. And you negotiate that price usually on a square footage basis. Additional rent tries to capture all the expenses associated with owning and operating a commercial property that you lease to others. And most of us are familiar with those concepts. These are often known as common area maintenance—and within that large umbrella, the tenant is responsible for paying, usually on a pro-rata basis or a per square foot basis—a share of regular maintenance of the property, some capital improvements to the property—but not all and we’ll discuss what the difference is—security for the property if it’s offered, landscaping, in the Northern States, snow removal—

Steve Freeman: What about property taxes? Are those included as part of other expenses?

Steve Katkov: Property taxes technically fall under that large umbrella we call common area maintenance, even though it’s a bit of a misnomer. And a tenant needs to be confident that the description of common area maintenance captures all of the moving parts that the landlord—In all the expenses, the landlord intends the tenant to compensate him for. So in some leasing—And of course it’s all over the board. We see very, very sophisticated commercial leases, and not so sophisticated ones. Property taxes are as a percentage of your space as to the whole. That’s the concept of pro-rata. If you take 10 percent of the landlord’s property, you can expect it to pay 10 percent of his property tax bill. So a lease must be very clear on property tax because depending on the state in which you operate, that can be the most expensive portion of the additional rent. In addition to that, of course, are the common area maintenance, and to be very clear with your landlord that if the landlord decides to hire window washing of all the store fronts, that you are on the hook to pay that. Because there are many assumptions about common area maintenance, and that’s sweeping the sidewalks, and vacuuming common areas, or cleaning the bathrooms if the facility has one bathroom that is shared by all tenants. Those expenses are ones that the landlord will expect tenants to compensate him for.