Commercial Real Estate Leasing Guide

INTRODUCTION

A commercial lease is a legally binding agreement to rent commercial property for a set amount of time under strict criteria. While some large companies may sign commercial leases on a regular basis (and have legal representation on retainer to protect their interests), many businesses will only sign one commercial lease every 5 years.

Since this lease will be one of your biggest expenses—and is closely connected to the success of your business—it’s essential to make sure that you and your business are protected.

In this guide, I’ll explain the details of a commercial lease, but the most important rule for any business is this:

Always use your own Commercial Realtor® to negotiate terms and help to finalize the lease.

While listing Realtors® (the one whose name is attached to the listing) are always happy to help tenants execute a lease for you as an unrepresented party, their legal duty is to their client (the landlord). Make sure you work with your own Realtor®. Also make sure you choose a Realtor® who specializes in Commercial Real Estate as it requires a very different set of skills and experience than Residential Real Estate does.

Wants and Needs

A lot of people want things that are just not available in a market currently like the one in The Okanagan. In a market like this one you’ll need to focus on your needs first and then your wants. So make a list of both for your Realtor® so they know what to look for.

Know Your Zoning

The Business Development Bank of Canada (BDC) has a good article on how zoning and bylaws can impact your business. In short, different areas will have different rules for what businesses can do within a property.

Below are links to local zoning bylaws. It’s your job to confirm that your business fits within the zoning bylaws—not the landlord’s. You don’t want to sign a lease for a property you can’t use, because you will still be liable for the lease even if the city wont issue you your business licence. So make sure your Realtor® includes the proper subjects to protect you and give you time to confirm your zoning and the issuance of your Business Licence.

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WHAT YOU NEED TO KNOW ABOUT COMMERCIAL LEASING

Advertised Pricing

One common area of confusion is the way price is expressed. If a space is advertised as $14/sq ft, and is a 2000 sq ft space, then multiply that price by the square footage and that is your annual total. Divide that by 12 for your monthly rent and you will need to add 5% GST to this amount as well.

Example:

$14/sq ft x 2000 sq ft = $28,000 annually

Divide by 12 and you get $2,333.33

plus 5% GST works out to $2,450 per month

This amount will not include your Triple Net expense. More on that below.

Types of Leases

The majority of leases you're going to find listed on the M LS are going to be triple net leases, however there are some alternative types of leases that you will see once in awhile as well.

Gross Leases: are the simplest to understand because it’s simply a flat rate you pay to the landlord that includes everything other than GST and your own utilities.

Modified Gross Lease: involves a flat rate, plus a portion of incidental costs. Incidental costs can include things like property tax, repairs, and maintenance of common areas like sidewalks and the foyer of an office building.

Double Net Lease: uses the acronym NN, requires you to pay the base rent as advertised, plus your proportionate share of property taxes and insurance.

Triple Net Lease:  uses the acronym NNN and is the most common type listed on the MLS® today. This means you will pay the base rent, plus your proportionate share of the landlords property taxes and insurance as well as other costs for building operations and maintenance.

The triple net lease is the most difficult to budget for, as those other costs can really add up, and won’t be the same every year. It’s so important to work with a knowledgeable Realtor® who can help you and your lawyer navigate the lease before signing it.

Percentage Rent Lease: This is common for retail businesses in malls. You’ll pay a set base rent, plus a percentage of your business’s gross sales (over a set minimum).

More About Triple Net (NNN)

This rate is not included in the advertised listing price. This amount is usually only expressed in the back end of the MLS system where Realtors can see, however sometimes the listing Realtor® does not include it and your Realtor® will have to call and get this information directly. NNN is also expressed as a per sq ft amount and it can range typically from $3-$9/sq ft. depending on the age and style of building.

Although the triple net expense does include your proportionate share of the landlord’s property taxes and insurance it's very important to remember that this does not cover your own insurance. You will need to get your own tenants’ policy which properly ensures you as well in the event of any destruction and the landlord will require coverage for his building if you were liable for any damage or destruction.

While triple net can include some utilities (which are on a shared meter with the other units in the building) most of the time the units will be individually metered and therefore you will hook up utilities in your own business name, which you will pay separately.

OTL (Offer to lease) vs. a Lease Document

It is important to understand that the first stage of securing a property (once you've identified as the one you want) is having your Realtor® draft up The Offer To Lease, or OTL.

This document is a high-level overview, or offer, to see if the landlord is interested in your use of the property and if you can agree on rates and term as well as any material subjects and conditions that either of you may have. This document is not the actual lease and does not bind you to the property, yet, but shows a legal intention to procure the property. Once the OTL is accepted then the landlord will have a certain number of days, as described in the OTL, to get you a copy of the formal lease document. The OTL will also outline how many days you have to go over the lease document with your own lawyer. This will be the time to negotiate the more specific details with the landlord and also to get full disclosure on what is included and what is not included with your commercial lease.

Make sure you’re in contact with your lawyer in advance so they’ll have time to review within your deadline.

Understanding the Deposit

There are no laws regarding deposits on a commercial lease like there are for residential ones, it is a negotiation. However, there are industry norms. Even though it is desirable to hold onto cashflow for your business, a larger deposit is good in a competitive market—like the one here in the Okanagan. This is often a minimum of 2 months’ rent where half is applied to your first month’s rent, and the other half is held as a security deposit. Some landlords may ask for more depending on the security & history of the business. A new business with no track record is more likely to be required to provide anywhere from 3-6 months as a deposit.

Fixturing Period

A fixturing period is the time you need to get the property ready for operations. Your Realtor® will typically ask for 1-2 months’ free rent to allow time to get the set up and improvements done. Even if there’s no work to be done it is still an industry standard to be provided this time.

Gross Ups

If you’re in a strata building, gross ups are your proportionate share of strata expenses. Typically you should not be paying triple net and strata fees so make sure your Realtor® is there to assist you with this.

Escalations

Escalations are annual increases in rent to account for inflation and market growth. They are usually .50 or $1 per sq ft per year. Including escalations in your OTL makes your application stronger in hot markets, or if it’s a desirable property and there’s competition for it. As your Realtor, I can find out important details about the competition (other businesses trying to get the same space) and what escalations to offer to give you a better chance of securing the property, if any at all. However, even if they are not included in your OTL expect to see them in your counteroffer.

Who Does the Improvements?

In residential rentals, the landlord often does things like paint and replace carpets before you move in. In commercial leasing however, and in a marketing this competitive that is not often the case. Right now in the Kelowna area the landlord is more likely to agree to do improvements for office space because there is an influx of that. However, that is not the case for warehouse, industrial and commercial space currently. Although the landlord will likely agree to allowing you to do the improvements, don't expect to have him cover the cost of them.

Covenantor

A covenantor is a personal guarantor on the lease. It’s usually not added in unless requested by the landlord, who does it to protect themselves in case a business shuts down and will be seen more commonly with newer and start-up businesses.

Permitted Use Clauses

This lists what type of business activities can occur on the property. Be very careful with this! If it’s too specific you may restrict your ability to expand. For example, instead of a permitted use of ‘pet product sales’ your Realtor® should draft it as ‘pet and pet-related products, sales, and services’, giving the business room to grow and consider new revenue streams without breeching the lease.

Landlords have complete freedom to decline a commercial tenant if they are not interested in that tenant’s use of the premises. In a competitive market like we see in Kelowna, you always want to put your best foot forward so you can make sure to secure the space you need for your business.

Book Your Lawyer

It’s important to have a commercial lawyer engaged and ready to go when you find the right property. Never, never, never sign a commercial lease without getting independent legal advice.

Since your lawyer will need some time to review the lease, make sure they’ve set aside the time when you issue the OTL. Any delay in response can cause the landlord to decline the entire deal. You can certainly ask for an extension if you need extra time, but you won’t always get it. (We’ll cover the whole timeline in detail further.)

Mitigation

For residential leases, the landlord has a legal obligation to mitigate damages (such as trying to rent out a place quickly if the tenant leaves mid-lease) but this isn’t the case in commercial. They can leave it vacant for years and then come after you for the entire amount owing.

Cancellation

Commercial Leases do not generally have any termination clauses so get your Realtor® to add in a condition to sublet if you think you may outgrow the property before your term is up. This can protect you and ensure you can expand your business when it’s the right time.

Terms

Most landlords listed on the MLS® are looking for a five-year term. Sometimes your Realtor® can negotiate for as low as three if that is what your business plan requires. In this current market terms shorter than 3 years are generally not being considered.

Have Your Brand and Business Plan Ready

Commercial landlords are often very specific about the types of businesses they want in their building. The big difference between buying a building and leasing is that you are pitching your business idea to them when you make an offer to lease, so be prepared to show the best of your business.

Different Realtors® in town have different requirements when it comes to vetting proposed tenants for their landlords so make sure that your website is looking good and you have a simple business plan together with ideas on your proposed use of the property and how your brand would best benefit that specific location. This will help entice the landlord to select your business over another that may be vying for the same property.

Credit Checks

And get those financials in order before you start viewing properties. You’ll need to show the potential landlord that you’re in a good financial position and can support your lease. Landlords have become even more cautious about only accepting tenants that have strong financials so make sure you have 2-3 years financials ready for review in case you are asked for them.

Landlords will also typically ask for a 2-page credit form where you disclose your business assets, liabilities, net worth, and vendor references. Start-ups may also need to give a bank statement that shows strong financial position but it’s not likely that they’ll run a formal bureau credit check.

CONCLUSION

A commercial lease on the right property can be the key to a successful business. Find the right Realtor®, know exactly what you need, and negotiate the lease that will successfully take your business into the future. If you are considering Leasing, Buying, or Selling Commercial Property in the Okanagan, call me at 250.448.5008 or email samantha@shopcommercial.ca and I would be happy to discuss your goals with you.

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