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Definitions and Discussion of Basic Lease Terminology

By: Jeffrey Lerch, CPM

The commercial real estate transaction is full of terms and provisions that can be confusing to many. The following terms are among the most common and are encountered in nearly every lease found in today’s marketplace.

Additional Rent: Any amount paid by a tenant over and above Base Rent. Additional Rent may include Operating Expenses, CAM Charges, Late Charges, Interest, or other. The reason these items are referred to as “rent” stems from the landlord’s ability to recover such charges in the event of default by tenant. If they were not considered rent, many charges might be dismissed by the courts, leaving the landlord unable to recover.

Broker Representation: Broker Representation can be an important factor in negotiating a lease. Brokers are typically experts in commercial real estate negotiation and act as the tenant’s advocate in procuring leased premises. However, not all brokers operate equally or have the same motivation. It is important to understand the difference in choosing a broker and how such a decision can impact the economics of the final lease transaction. Read More » (Article - Choosing a Commercial Real Estate Broker)

CAM Charges: CAM is an acronym for Common Area Maintenance Charges, which refers to a form of Additional Rent paid by a tenant, which are frequently tied to increases in the building Operating Expenses from year to year.

Class A Building: Any building that is considered to be in excellent overall condition. Class A buildings command the highest rents, are generally more prestigious, and offer tenants more services and amenities. Their hallways are generally wider, ceilings higher, and column spacing wider. Class A buildings will have high quality finishes, state-of-the-art mechanical systems, and are professionally managed. Although the definition can be highly subjective, Class A buildings are often considered to be at least 4 stories tall, having steel frame construction, and located in the city center. By definition, many newer buildings may be considered Class A if they are of high quality, but older buildings may be considered Class A if they have been renovated.

Class B Building: Any building that is in good (not excellent) overall condition, with average finishes and functionality. Class B buildings are generally 3 stories or less, although older high-rise buildings may be considered Class B if they have not been recently renovated or modernized. Rents are in the middle range of the market, but can vary widely depending upon the condition and location of the building.

Class C Building: Any older building with some functional defects. Rents are generally below the average for the area.

Commencement Date: The starting date of the lease obligation. Importantly, tenants can still have liability for actions taken prior to the Commencement Date, which makes it important to understand the full terms of the lease if you are granted Early Occupancy.

Default: Default is the failure to comply with an obligation required under the lease contract, which may be monetary or non-monetary. Landlords can seek eviction for nonpayment of rent, or performance of the lease for non-monetary items. Default, can quickly invalidate tenant’s rights for renewal, expansion, and more.

Early Occupancy: A period of time wherein a tenant has the right to occupy premises (generally without cost) prior to the Commencement Date of the lease. Early occupancy may limit a tenant to those actions that would prepare them for business, but preclude them from actually engaging in business activities.

Effective Date: A specific date referenced in the lease that becomes a benchmark for obligations to commence. The Effective Date and Commencement Date are often used interchangeably, except in cases where an existing lease is being modified, in which case the term Effective Date often prevails.

Effective Rent: The average rental rate over the term of the lease after deducting landlord concessions such as free rent, moving allowance, or over-standard tenant improvements. Often quoted as a rate per square foot.

Estoppel Certificate: A written statement by a tenant that the lease is in full force and effect, without default, and conforming to the economics of the lease. Estoppels are typically required when a building is being sold, transferred, or otherwise encumbered (ie: a new loan). A tenant’s failure to produce an estoppel can be cause for default, if so stated in the lease, which can lead to significant problems. See Default.

Expiration Date: The date that the lease obligation ends. Importantly, tenants can still have liability after the Expiration Date, especially if they remain in possession of the premises as a Holdover tenant.

Full Service Gross Lease: A lease where all building services, including electricity and janitorial service, are included in the Base Rent without additional cost to the tenant. Tenants are required to pay for increases in the cost of these services over a Base Year. Read More » (Article - Understanding Rent and Additional Rent)

Free Rent: Free rent is a common concession offered by landlords to entice tenants to enter into a lease by offsetting relocation costs. One month of free rent per year of lease term is considered the “norm,” but this amount decreases quickly as occupancies increase and market conditions tighten. Free rent, along with other concessions, can be recovered by landlords if a tenant defaults on their lease. Sometimes, exchanging free rent for a reduction of Base Rent is a preferable alternative, although it is not always desired by landlords as it reduces their monthly rental income, thus reducing property value. A full analysis of alternatives should be performed prior to finalizing concessions and lease terms.

Gross Lease: A type of commercial lease where the landlord pays for all of the costs associated with owning and operating a building. Tenants are required to pay for increases in the cost of these services over a Base Year. Read More » (Article - Understanding Rent and Additional Rent)

Guaranty Agreements: Landlords may require a personal guaranty where a lack of financial strength exists for the entity behind the lease obligation. New corporations or limited liability companies are often asked for this pledge, given their lack of tenure and financial strength. There are, however, alternatives to the guaranty, which may include posting additional security deposit or prepaid rent.

Holdover: “Holdover” represents a tenant possession of premises following the contract term of the lease. Although many tenants consider this a simple “month-to-month” option that provides flexibility and a lack of leasehold commitment, landlords take a different view. In order to fully appreciate the implications of this concept, one must first understand the impact to the landlord of a month-to-month lease.

Holdover: Continuing to occupy premises following the natural expiration of a lease. Also referred to as Tenancy at Sufferance. Holdover tenants generally do no have the right to continue to occupy the premises absent permission from the landlord, which can either be express or implied. The tenant’s original lease will often have specific terms regarding Holdover regarding rent or damages payable by the tenant. Holdover rents often range from 125% - 200% of the last monthly rent under the term of the lease, which is intended to encourage the tenant to either sign a new lease or move, since month-to-month tenancies have no value to a prospective purchaser.

HVAC: An acronym for Heating Ventilation, and Air Conditioning. Generally used when referring to the comfort systems in a low-rise building.

Insurance: Commercial leases typically require at least four different insurance policies or a combination of coverage, which may include: Commercial General Liability; Workers’ Compensation; Tenant’s Personal Property; and Loss of Income. Depending upon a tenant’s use, some landlords will also ask for Auto and other policies. Evidence of each of these policies is often required prior to granting possession to the premises. It is important for tenants to anticipate these additional coverages and their costs, prior to entering into a lease agreement.

Modified Gross Lease: A commercial lease where the landlord maintains the building, but the tenant is required to pay for certain services in addition to Base Rent, such as janitorial and electricity. Read More » (Article - Understanding Rent and Additional Rent)

Net Lease: A lease where the tenant is required to pay for building costs in addition to Base Rent. All of the building services may be provided by the landlord, including electricity and janitorial service (some office leases); however, certain Net Leases may require the tenant to contract and maintain building services (typically industrial leases). Still other Net Leases may require a combination of both (industrial, office, or retail). Net Leases can be further defined as Single Net, Double Net, Triple Net, or Absolute Net, with the differences being the nature of the services that are paid for by the tenant. Read More » (Article - Understanding Rent and Additional Rent)

Non-Disturbance Agreement: Protects a tenant from loss of its premises in the event of default by another party. If the owner is foreclosed, a non-disturbance agreement from the lender protects the tenant. If a sublessor defaults on a lease, the non-disturbance agreement from the owner protects the subtenant.

Operating Expenses: Also known as CAM, Expenses, or Maintenance Fees, landlords have many ways of passing additional costs on to tenants. Typical methods are Base Year or Net. More. Read More » (Article - Understanding Rent and Additional Rent)

Rent: Tenants and Landlords think of rent differently, which is a critical departure when it comes to understanding bottom-line economics of a real estate transaction. There are many ways of quoting rent, but the most common are: Full Service, Modified Gross, or Triple Net. Read More » (Article - Understanding Rent and Additional Rent)

Repairs and Maintenance: Obligations to repair and maintain leased premise can vary widely depending upon the terms of the lease agreement. Office tenants frequently believe that all maintenance obligations are the responsibility of the landlord, however this is rarely true. Industrial and retail tenants are generally responsible for all maintenance within the walls of their premises. Certain leases will require tenants to maintain every part of the property, including the roof and structural components. The key is to read the lease very carefully to know exactly what obligations you will have as a tenant.

Right of First Offer (ROFO): A right to have the first opportunity to negotiate a lease or purchase of property when it becomes available. If accepted, the holder of the right will attempt to negotiate a satisfactory transaction. If a transaction cannot be completed, the landlord/seller is free to market the property to prospective third parties without further obligation.

Right of First Refusal (ROFR): A right to match the terms of a bona-fide offer to lease or purchase property. If accepted, the holder of the right must complete the transaction under the same terms as presented. If rejected, the landlord/seller is free to consummate the transaction with the prospective third party tenant/purchaser. An ROFR is generally preferred to a Right of First Offer, as it requires an actual transaction to be considered before the holder of the right must act.

Security Deposit: Landlords often require a tenant to post a cash or cash equivalent prior to entering into a lease transaction; however, the obligation or manner of security is not always the same, or even required at all. Large corporations can avoid posting security given their history of financial strength and stability.

Subleasing: Subleasing allows a tenant to substitute another to fulfill a portion or all of a lease obligation. Typically, the original tenant remains primarily responsible for full performance of the lease. In The United States, landlords cannot prohibit tenants from subleasing their premises, although they can place significant restrictions on who is sublet to, what their use is, and how much the sublet rent can be. Subleasing is different from Assignment wherein the tenant transfers the entire interest (and obligation) in real property to another.

Subordination Agreement: An agreement with the lender holding a note on a property to recognize a tenant’s lease as superior to its own rights to the property. In the event that the lender forecloses, they agree to recognize the tenant’s lease. Absent a subordination agreement, a foreclosing lender may elect to terminate a tenant’s lease without reason or compensation.

Square Footage: Tenants often believe that Rentable Square Footage represents the actual space occupied. However, this is not always the case. Where square footage for a retail or industrial lease may, indeed, equal the space occupied within the occupied premises, Rentable Square Footage quoted in many office lease transactions is often greater than the actual space that is occupied. Read More » (Article - Understanding Rent and Additional Rent)

Tenancy at Sufferance: See Holdover.

Tenant Improvements:
Tenant Improvements generally refer to any improvements rendered to the premises by either landlord or tenant, regardless of financial obligation. Lease negotiations provide the basis for such obligation and must be negotiated prior to the execution of the lease document. Landlords typically offer to fund such improvements as incentive to lure prospective tenants to their building, called a Tenant Improvement Allowance, which are generally capped at a dollar amount or Building Standard quality of finish. Above Standard Tenant Improvements are those improvements that exceed the Building Standard and are generally the financial obligation of Tenant.

Waiver of Subrogation: An agreement between two or more parties (generally insurance companies) to waive their rights to recover against each other in the event of a loss. The concept requires the party to recognize its own responsibility without seeking retribution from another.