Understanding commercial leases and their various purposes is critical knowledge for landlords and commercial tenants but the truth is that they can be very confusing. Well, LasVegasRealEstate.com readers you are in luck because we are going to break it all down right here in easy to understand language. Here we go!
Understanding Commercial Leases – What is a lease?
A lease is a contract (implied, verbal or written) which transfers possession rights from an owner (lessor) to a tenant (lessee). While the tenant is entitled to exclusive possession during the term of the lease, the lessor retains the title (ownership) and reversionary rights to take possession at the end of the lease. Therefore, ownership never transfers in any type of lease.
A lease is the only way an owner can legally profit by property ownership (during the ownership) if the owner does not use the property for his/her own business, agriculture or housing needs.
Why is a lease used?
There are many benefits to a lease. One benefit often overlooked is the security from a possible market correction. Tenants can most often secure a specific monthly payment without the threat of losing the capital invested in a property interest. The great recession is recent enough in all our minds to remember the sheer pain suffered by building owners. If those building owners had leased their space needs instead of purchasing the building, they could have avoided a significant loss in asset value. If these purchasers could have predicted or foreseen the decline, a lease might have been a better option.
Leases are also often used by prospective owners that cannot qualify to purchase or are uncertain about a potential purchase of a property. Leases provide the balance for housing that is needed for those who don’t wish to own at a given time.
The validity of the Lease
The statute of frauds mandates certain contracts be in writing. The contract must be signed by the person who is being held to the contract. This statute includes leases for more than one year. Therefore, oral leases one year or less need not be in writing and many are not. Though some leases may be verbal or implied it is extremely difficult to enforce aspects and terms of the lease without a written and signed contract to confirm that all parties are aware of the terms.
Oral Lease Examples and Conditions
An oral six-month lease, which could ordinarily be enforceable, would be unenforceable if it were not to begin for seven months. By the terms of such a lease, it would take more than one year for full performance (7 months to start + a 6-month lease = 13-month performance.)
An oral lease that continues or automatically renews after 12 months would be unenforceable after the 12-month period unless a period existed without any oral terms of the lease.
By setting forth terms as a written contract the landlord is protected against a situation where the lessee claims the verbal agreement was different from the actual agreement. Both parties are protected by written contracts because people tend to have sketchy memories and remember agreements in a manner favorable to them.
Understanding Commercial Leases – Types of Leases
The ESTATE FOR YEARS is the most common type of leasehold interest in real property. It is actually any estate created for a fixed period of time and need not be for even one year. There are three guidelines to follow when drafting an Estate for Years Lease:
- The terms must be certain
- No notice is required to terminate
- No maximum duration
Notes: The Statute of Frauds requires “a lease for more than one year must be written.” A majority of American courts have also held that the fixed term and any additional option periods are added together. If the total term exceeds the statutory period, a written lease is mandated.
The PERIODIC TENANCY, commonly known as week-to-week or month-to-month is a tenancy which continues from one period to the next automatically, unless either party terminates the agreement at the end of a period, by written notice, which is usually the same length as the original rental period. The creation of a periodic tenancy usually arises from a lease holdover.
A gross lease is a lease where the landlord agrees to be responsible for all expenses which are normally associated with ownership of the leased premises, such as maintenance (includes utilities and repairs), insurance, and taxes. A tenant to a gross lease is only responsible for paying the monthly lump sum base rent and the landlord is responsible for operating the building and all other costs associated with the premises. The tenant’s base rent usually includes building operating costs. In today’s commercial marketplace a gross lease is very rare.
A net lease is a lease where the tenant has primary control of the premises and agrees to be responsible for some or all the operating expenses of the premises, such as utilities, repairs, insurance, or taxes. A tenant who has a net lease is responsible for paying the monthly lump sum base rent as well as some or all of the operating expenses.
Types of Net Leases
Net leases define the responsibilities of the landlord and the tenant differently. The following are the four types of net leases:
Single Net Lease – A single net lease is a net lease where the tenant agrees to pay a monthly lump sum base rent as well as the property taxes. The landlord is responsible for all other operating expenses of the premises.
Double Net Lease (NN) – A double net lease is a net lease where the tenant agrees to pay a monthly lump sum base rent as well as the property taxes and the property insurance. The landlord is responsible for all other operating expenses of the premises.
Triple Net Lease (NNN) – A triple net lease is a net lease where the tenant agrees to pay a monthly lump sum base rent as well as the property taxes, the property insurance, and the maintenance. Under a triple net lease, there are a few legal defenses that may relieve a tenant of his responsibilities. For example, a triple net lease may relieve the tenant of his responsibility if the property is subject to the eminent domain proceeding.
Absolute Triple Net Lease (Bond Lease) – An absolute triple net lease is a net lease where the tenant agrees to pay a monthly lump sum base rent as well as the property taxes, the property insurance, and the maintenance. Under an absolute triple net lease, there are no legal defenses if a tenant fails to meet his responsibilities.
What is a percentage lease? A percentage lease is a lease where rent payments are based on the lease holder’s sales or profits. A typical percentage lease will have a base rent or a minimum amount of rent that is due each month. In addition to the base rent, the leaseholder must also pay a percentage of the gross or net sales each month, as stipulated in the lease agreement. The lease should state exactly what counts as a “sale” to be included in the calculation of what rent is due.
A ground lease is a lease of land only and is also commonly referred to as a land lease. At the end of the lease, the lessor gets possession of the property and generally the improvements placed on the property by the tenant. Many of the free-standing sites in shopping centers, such as those pads for fast-food restaurants, are ground leases. The tenant puts up the building and is responsible for all improvements. The owner keeps the title to the property and pays no capital gains taxes, although the owner is taxed on the rent collected.
Ground leases are usually net leases where the tenant pays taxes as well as all other expenses. They may also have a percentage of the rent feature where they include a percentage of the gross in addition to the net amount. This may be in conjunction with a Consumer Price Index (CRI) feature of the net lease. The CRI and the additional percentage serve to provide a measure of protection against inflation for the owner/landlord.
Most large franchisors and corporations with retail storefronts prefer ground leases as they expand their footprint since they avoid tying up large sums of cash in the land. Another advantage is that some owners will accept a much lower rent than the value of the land would normally dictate because they are going to own the tenant improvements at the end of the lease.
Assignments and Subleases
An Assignment is very similar to a sublease, except the new tenant takes on the rights and obligations of the entire lease, not just for a limited amount of time. In the case of an assignment, there is usually a contract between the new tenant and the original landlord, where one is lacking in a sublease. The original tenant is usually still liable for all the obligations of the original lease until it expires. Assignment vs. Sublease is one example of why understanding commercial leases and the liability each type creates is important knowledge.
A Sublease, or sublet, is a contract between a pre-existing tenant and a new tenant. For example, tenant A may have a lease with Landlord A, but tenant A subleases the rented property to tenant B through a contract. Generally, the new tenant B takes on all the rights and obligations of tenant A, but for a limited amount of time. The original tenant A is still liable for all the obligations of the original lease with Landlord A until it expires.
Thank you for reading our post, “Understanding Commercial Leases.” For more information on commercial properties in Las Vegas, Henderson, North Las Vegas, or Boulder City, multi-family, retail, office, industrial space, and flex space or general real estate information please visit our website www.lasvegasrealestate.com.