Understanding Commercial Real Estate Lease Terminology

Understanding commercial leases can be overwhelming. I have created the following guide as a quick reference sheet for tenants, agents, and landlords who would like to get a better understanding of Commercial Real Estate Lease Terminology.

Disclaimer: I am not an attorney and this article is not intended as a substitute for advice from the appropriate legal, zoning, financial, construction and/or tax professionals. This information is provided for educational purposes only and is made without warranties or representations.    

Commercial Lease Terms

ADA Requirements – America Disability Association rules regarding a property’s accessibility. Commonly referenced for restrooms size, inclines of ramps and parking requirements.

Agreed Use – A narrow scope defining the nature of the tenant’s business/use of the space. Often times the agreed use clause will be incorporated to ensure co-tenants are not competing with each other. For example: A shopping center owner will not allow 2 Chinese restaurants within the same property but will allow an Italian restaurant and a Chinese restaurant.

Annual Escalations – Typically 2-5% this is the amount that the base rent increases each year over the course of the lease term.

AS-IS WHERE-IS – Under this provision the landlord or seller makes no warranties regarding the condition of the space and it is the sole responsibility of the tenant or buyer to make appropriate investigations of the property prior to moving forward.

Assignment of Lease – The change of a party to the lease agreement during the lease term. For example: if the owner of a restaurant sells their business the lease agreement will be assigned to the new business owner. Typically, an assignment of a tenant’s interest in a lease will require the landlord’s consent. Furthermore, when a property sells the lessor’s position in the lease will automatically get assigned to the new owner.

Base Rent – This is the amount paid monthly by the tenant, generally referred to in a “Price Per Square Foot” amount.

Base Year – In full service or modified gross leases, the landlord agrees to cover a tenant’s share of the annual operating expenses, but limits their annual exposure to an amount equal to the expenses incurred in the first year, or “Base Year.” The Base Year is, therefore, the actual (usually grossed up for full occupancy) operating expenses incurred by the building, usually in the first calendar year of a lease. Once established, this figure becomes the benchmark for future years to determine the tenant’s share of excess operating expenses, also referred to as “pass-throughs” in many leases.

Breach – A violation of the lease agreement.

Brokerage Fees – Commission paid by the landlord or seller to agents in a real estate transaction.

Built to Suit – A lease structure in which the landlord will build out a custom building or suite in exchange for a tenant signing a long term lease at a premium rent. Often time built to suit will be utilized for medical and hospitality types of businesses.

Capital Expenditures – Major improvements or maintenance to a property including: roof replacement, electrical or plumbing replacement, etc.

Commencement Date – This is the day in which the initial term of the lease begins.

Common Area Operating Expenses – Often abbreviated as CAM or NNN, common area operating expenses are the tenant’s monthly pro-rata share of the actual operating expenses of the property and are paid in addition to the base rent.

Common Areas – Any portion of the property that is shared amongst the tenants including: hallways, lobbies, shared restrooms, elevators, parking lots, etc.

Condemnation – Condemnation occurs when a local, state or federal government seizes private property and compensates the owner. The power of the government to do this is called eminent domain, which essentially means the government takes private property for public use.

Contingencies – Predetermined time periods or conditions made to provide either the landlord or tenant the option to back out of an agreement. For example, a lease can be contingent upon receiving specific permits/license from the local government.

Core Factor – The total common area square footage divided by the total property square footage expressed as a percentage. The core factor is used to determine each tenant’s prorated share of the common area space.

Early Possession – Often times the tenant will be given access to the premises prior to the commencement date to complete tenant improvements.

Estoppel Certificates – Documentation signed by the tenant to verify an existing lease agreement to a lender or prospective buyer.

Expiration Date – This is the day in which the initial term of the lease ends.

Fair Market Rate – Used for calculating the rent on a lease renewal. FMV is determined by taking a survey of rents of comparable properties in the market area. 

First Right of Refusal – The tenant has the option to purchase the property at a pre-determined price prior to the owner being able to sell to anyone else.

Full-Service Lease – Under the full-service lease structure the tenant pays 1 bill each month which in addition to the base rent includes all utilities, internet, and janitorial service. 

General Commercial Liability Insurance – Insurance required by the lease that protects the tenant and the landlord against claims against the property. Most commercial leases require a “2/1 policy” which has $2,000,000 in total coverage and a maximum of $1,000,000 per incident.

Government Approvals – Licenses or permits that a tenant will need to obtain in order to open for business.

Gross Lease – The tenant/lessee pays 1 bill each month. The amount paid covers the base rent with all other associated costs being paid for by the landlord/lessor. Landlord responsibilities under this type of lease include building maintenance, utilities, insurance, and property taxes. This type of lease is most commonly used for office space.

Ground Lease – Under a ground lease, the lessee leases the land and builds all of the structures and is responsible for all maintenance and development.

Guarantor – An individual or entity responsible for the performance of the tenant’s obligations under the lease agreement. In the case of a tenant’s breach of the agreement, the Guarantor’s credit and assets serve as collateral in terms of the landlord’s recourse.

Hazardous Substances – Any chemical or waste that could threaten human health or the environment. “Hazardous substances” include those substances that are “hazardous wastes.”

Holdover Period – The time frame in which a tenant remains in possession of the suite after the expiration of the lease and prior to coming to agreement on the renewal terms. Generally, the base rent is increased to 150% during the holdover period.

HVAC – Heating Ventilation Air Conditioning

Indemnification – Security against legal liability for one’s actions.

Inducement Recapture – If the lessee does not fulfill their duties under the lease then all concessions including rental abatement(free rent) or tenant improvement allowances shall be repaid to the lessor. 

Initial Term – This is the length of the lease not including renewal/extension options.

Landlord Rep Broker – A real estate professional employed by the property owner to market and secure new tenants. Furthermore, the landlord rep broker will negotiate renewals of existing leases upon expiration of the current lease term.

Late Charges – A penalty applied to the tenant if they fail to pay rent on time. Late fees are typically $100 or 10% of the monthly base rent, whichever is greater.

Lessee – Also referred to as the tenant, this is the party that is renting the space.

Lessor – Also referred to as the landlord, this is the party that owns the property and is leasing it to the tenant.

Liens – A cloud on a property’s title in relation to an outstanding debt. Typically a property can not be sold without satisfaction of the outstanding liens.

Live Work – A commercial suite that also allows residential use. Often used for artist and freelancer type of business: Photography, Graphic Design, Real Estate, Etc 

Master Lease – The original lease on a property. Any subleases must also abide by the terms of the master lease.

Modified Gross Lease – The tenant/lessee pays for the base rent as well as the utilities provided to their unit within the property. The landlord/lessor pays all other operating expenses of the property. This type of lease structure is used for a wide variety of commercial properties including office, retail, and industrial space.

Net Worth of Lessee – The cumulation of all assets and liabilities of a tenant. The net worth of lessee is most often used when the lease is being assigned to a new tenant whose financials will need to be of equal or greater value than the current lessee.

Non-Disturbance – Refers to an agreement between a tenant and the landlord’s lender to ensure the tenant will remain in possession of the leased property, despite any foreclosure action against the landlord.

Percentage Lease – Under the percentage lease structure the tenant pays a portion of their gross sales each month to the landlord. The percentage lease structure is most commonly used at shopping malls or restaurant spaces

Premise – This refers to the specific area within the property that is being leased.

Prohibited activities – Specific restrictions on the space. For example: Storing or selling marijuana products, overnight parking or vehicles, utilizing the space for residential use.

Project – This refers to the property as a whole.

Remediation – The action of remedying something, in particular of reversing or stopping environmental damage.

Remedies – The solutions provide to the landlord or tenant in response to a breach of the lease.

Renewal Option – A tenant’s predetermined option to extend the lease after the expiration of the initial term.

Rentable Square Footage – The total square footage used for calculating the base rent. Rentable square footage is calculated by multiplying the rentable square footage by the property’s core factor. For example: a 1,000 square foot office within a building with a 15% core factor would have 1,150 rentable square feet.

Rental Abatement – Also know as “free rent”, rental abatement is an incentivize offer to tenants in order to facilitate a lease or renewal.

Replacement Cost – The cost the rebuild all or part of a piece of real estate.

Sale Lease Back – An investment sale strategy in which an owner-user will sell a building that occupy and lease it back in order to free up working capital. 

Security Deposit – A refundable portion of the tenant’s initial payment held by the landlord over the course of the lease term to protect the landlord against the tenant breaching the lease agreement.

Service Contracts – Contracts to maintain a properties system. Most commonly the HVAC units.

Signage Policy – Rules governing the size and location of a tenant’s signs on a property. Often times rights to signage will be negotiated prior to signing the initial lease term.

Subleasing – When a tenant leases all or a portion of their suite. Generally, subleases require landlord approval and do not relieve a lessee of their lease obligations.

Subordination – A subordination clause is a clause in an agreement that states that the current claim on any debts will take priority over any other claims formed in other agreements made in the future. Subordination is the act of yielding priority.

Tenant Improvements – Alterations made to the premise to accommodate the tenant’s specific use. The cost for improvements are generally negotiated prior to signing the lease.

Tenant Rep Broker – A real estate professional employed by a tenant for the purpose of located and negotiating new lease agreements as well as representing the tenant in negotiating lease renewals.

Term – This is the length of the initial lease, generally expressed as a number of months.

Termination Option – A tenant or landlord’s option to conclude the lease term prior to the expiration date. Typically the party exercising the option will provide financial consideration.

Trade Fixtures – Improvements to the space that are specific to the tenant’s business, For example: grease traps, stoves, compressors, industrial equipment.

Triple Net Lease – Under the triple net lease structure the tenant/lessee pays the base rent as well as their pro-rata share of all the operating expenses for the property. The landlord is responsible for maintaining accurate accounting of the property’s operating budget and reconciling the NNN expenses on an annual basis. This type of lease structure is most commonly used for retail shopping centers and large multi-tenant industrial properties.

Usable Square Footage – The total square footage of a suite measure from the interior edge of each wall.

Workers Compensation Insurance – Provides medical and wage benefits to people who are injured or become ill at work.

Conclusion

Commercial leases can be very specific to both the property and the tenant’s use. It is always recommended that you consult with an attorney prior to signing any legally binding document.

Have additional questions? Want advice on your current lease? Reach out to me through the contact page.

About Erik Egelko

Erik Egelko is a commercial real estate broker and Senior Vice President at SVN Vanguard, a national commercial real estate brokerage firm with offices in San Diego, Orange County and Los Angeles as well as over 220 offices throughout the United States. With roughly 10 years of experience in the industry, Egelko has built a reputation for himself as a dedicated and knowledgeable professional who strives to exceed his clients’ expectations.

In 2021 and 2022 Erik was inducted into the “Partner’s Circle,” the highest level of achievement for SVN. Erik is currently ranked in the top 1% of investment sale brokers nationwide.  

Egelko’s approach to real estate is based on building long-term relationships with his clients, providing personalized service and attention to detail. He is committed to understanding his client’s needs and objectives and works tirelessly to ensure that they achieve their goals. If you own a commercial property and would consider listing it with a broker, give Erik a call at 805-415-1914.