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Not All Commercial Leases Are Alike

In looking for a place to establish a storefront business – restaurant, retail or otherwise – owners and managers must take many factors into consideration. One of those is the type of commercial lease agreement that will be negotiated with the landlord.

Unlike a residential lease, which often are set at a flat rate, a commercial lease, particularly one in a prime location, involves a  landlord asserting rights to a portion of the tenant’s gross sales above a certain percentage. It offers a way for landlords to share in a tenant’s financial success.

Our New York City commercial lease attorneys recognize the terms of these agreements depend heavily on the type of business, the value of the venue and the estimated calculation of gross sales. While landlords will often attempt to draw a hard line in the sand, these terms are often negotiable. For business owner tenants, consulting with an experienced commercial lease lawyer to help facilitate these negotiations can result in significant savings over the course of the lease term.

To offer a better understanding of the need for assistance in this process, it’s important to explain the different types of leases  offered and why not all commercial leases are alike . The two most common types are gross leases and triple net leases. There are advantages and disadvantages to both, and it’s key for tenants to learn how they might be impacted in each scenario.

In a gross rent agreement, a tenant agrees to pay a set amount, while the landlord is legally and solely responsible for all other expenses, which will include things like maintenance, insurance and taxes. This type of agreement tends to be fairly straightforward and tenant-friendly. However, the downside is that the base rental rate tends to be far higher than what one would expect to see in a triple net rental agreement.

In these situations, budgeting for rental costs is easier. However, tenants risk the prospect of being responsible for a rate they may not be able to easily afford if sales fluctuate significantly from one month to the next.

This is why alternatively many commercial landlords offer triple net leases. Sometimes, these agreements are referred to as a “net-net-net lease.” These tend to be more common in cases where there is a single tenant inside a building and the lease is long-term. Generally, it’s as close to ownership as a tenant may get, though the tenant name is nowhere on the deed.

Here, the tenant is going to pay a monthly base rent, in addition to real estate and property taxes, building insurance and probably most of the maintenance costs. Those maintenance costs often include ongoing expenses, such as landscaping and cleaning, as well as large and unexpected expenses, like roof repair.

The trade-off is that the base rent tends to be much lower than what you would see in a gross rent agreement.

While each contract is modified individually, a triple net agreement often includes a provision indicating that if the tenant grosses over a certain amount (sometimes referred to as the “breakpoint”), the landlord collects on a set percentage of the sales beyond that point.

Usually, the formula used is the “natural breakpoint.” This is the amount of gross sales that, when multiplied by the applicable percentage, is going to equal the amount of the annual fixed-rate rent. So the annual fixed rate rent is divided by the applicable percentage, which determines the natural breakpoint.

However, often tenants rake in profits at a lower gross sales volume than that natural breakpoint. This is why during commercial lease negotiations, landlords will sometimes press for a breakpoint that is lower than the natural breakpoint.

In some cases, it can still be a good deal for the tenant, but only if the location warrants it. Alternatively, tenants might agree to pay a larger fixed rent than what might otherwise be fair, in exchange for negotiation of a higher breakpoint.

When determining what constitutes a fair percentage for rent purposes, both sides need to take into account the estimated gross sales and payment schedule. Another concern for tenants is that landlords are allowed to occasionally audit the gross sales, in order to ensure the amount paid is what is truly owed.

The Wright Law Firm is a business law firm located in Midtown Manhattan. Call (212) 619-1500 for a confidential consultation.

Additional Resources:

Looking for a New Space to Call Home for Your Business – Three Common Types of Commercial Leases – Pros and Cons, July 2, 2014, By Brittany Finlayson, The National Law Review

More Blog Entries:

Bullets & Booze: Gun Range Gets Liquor License, June 18, 2014, New York City Commercial Lease Lawyer Blog

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