How Commercial Leases Differ from Residential Leases

 If you are a landlord, building owner, or stakeholder involved in leasing commercial property, understanding the distinctions between residential and commercial leases is crucial. Commercial leases, which apply to commercially zoned properties, contain detailed provisions about property usage, distinguishing them significantly from residential leases designed for daily living.

Residential leases offer substantial protections for tenants to ensure safe living conditions, often requiring landlords to maintain the property. Conversely, commercial leases are tailored for business use, typically outlining the permissible business activities on the property. These leases provide fewer protections for tenants, necessitating careful negotiation to align with the interests of both the landlord and tenant.

Legal Protections

Residential leases offer many legal protections that don’t apply to commercial contracts. They guarantee safe living conditions for residential tenants. Landlords are usually required to maintain the property. Conversely, a commercial tenant may be required to maintain the property unless it is explicitly provided for in the lease agreement. However, commercial leases can be customized to reflect the needs of the business and the landlord. They often dictate responsibility for maintenance of shared areas. 

Since the commercial lease is usually written by the landlord or his legal team, it most often favors the landlord. Be aware of clauses or covenants that address:

• Restrictive clauses that dictate business hours and how the property can be used
• Responsibility for repairs and maintenance, including repairs due to natural disasters and building age
• Responsibility for costs due to insurance, maintenance and new construction
• Rent increases
• Early termination conditions and commercial subleasing

When considering a commercial lease, it is wise to have it reviewed by a commercial real estate broker or a lawyer familiar with commercial real estate law.

Stricter and More Expansive Covenants

Commercial leases involve stricter and more expansive covenants compared to residential leases. These covenants are essential for landlords and building owners to protect their investments and ensure the property is used appropriately.

• Length and Binding Nature of Terms: Commercial leases typically span longer terms, often ranging from 3 to 10 years or more. This extended duration provides stability and predictability for landlords.
• Customization and Specificity: Leases can be highly customized, including specific covenants on business operations, hours of operation, signage, and alterations, ensuring property alignment with the landlord's vision and compliance with local laws.
• Allocation of Responsibilities: Detailed allocation of responsibilities, often shifting significant maintenance and repair duties to the tenant, is crucial to avoid disputes and ensure proper property upkeep.
• Financial Covenants: Financial clauses protect the landlord's investment, including rent escalations, operating expense pass-throughs, and percentage rent clauses tied to tenant revenue.
• Default and Remedies: Stringent default and remedy provisions, including accelerated rent clauses and the right to re-enter, are necessary to address tenant non-compliance and protect the landlord’s investment.
• Flexibility and Negotiation: While more complex and binding, commercial leases offer flexibility through negotiation, allowing landlords to attract and retain quality tenants, ensuring long-term profitability and stability.

Typically Customized to the Property and Tenant

Commercial leases are typically customized to suit the specific needs of both the property and the tenant. This customization allows for precise stipulations on how the property can be used, the type of business activities permitted, and any modifications or improvements required. For example, a lease for a retail space might include provisions for signage, store layout, and hours of operation, while an office lease might address interior build-outs and technology infrastructure. 

This tailored approach ensures that the lease aligns with the tenant’s business requirements while protecting the landlord’s investment and maintaining the property’s overall value and functionality. Customization also fosters a collaborative relationship between landlord and tenant, promoting long-term success for both parties.

Longer Commitments for Tenants

Commercial leases often require longer commitments from tenants, typically ranging from 3 to 10 years or more. These extended terms provide stability for both landlords and tenants, allowing tenants to establish and grow their businesses without the disruption of frequent relocations. For landlords, longer lease terms offer predictable income and reduced vacancy risks. 

However, these extended commitments also mean that tenants must carefully evaluate their business needs and future growth plans before signing. Tenants should negotiate terms that offer flexibility, such as renewal options or exit clauses, to accommodate potential changes in their business landscape. By securing a longer lease, tenants can benefit from stability and potentially more favorable rental rates while landlords enjoy a steady, reliable income stream.

Stronger and More Precise Use of Language

Commercial leases utilize stronger and more precise language to clearly define the rights and obligations of both parties. This specificity reduces ambiguities and potential disputes, ensuring that each party understands their responsibilities and the terms of the agreement.

Detailed clauses cover various aspects such as permitted use of the property, maintenance duties, and financial obligations. Precise language also helps in delineating the consequences of breaches and the remedies available. By meticulously drafting these agreements, landlords protect their investments, and tenants secure a clear framework for their business operations, fostering a professional and transparent leasing relationship.

Responsibility for Maintenance and Repairs

One of the most important differences between commercial and residential leases is assigning the responsibilities for maintenance and repairs. These responsibilities vary greatly based on negotiations between the landlord and tenant. 

Tenants with a full-service lease or gross lease pay a monthly rental payment that includes all expenses for the leased property. On the other hand, net leases require that the tenant reimburse the landlord for maintenance and repair costs or pay these expenses directly, as negotiated in the lease. Between these two extremes, there are other ways of determining who pays for these expenses. For more information about lease types and responsibilities consult a lawyer or real estate broker.

Check your lease for clauses that dictate who pays these expenses:

• Repair and maintenance of common areas
• Maintenance of heat, water, elevator, air conditioning, and other services
• Structural repairs including plumbing, electrical wiring, equipment and machinery on the premises
• Pest control and repair and remediation for damage and infestation caused by pests
• Ordinary maintenance and repairs of the premises
• Repairs from natural disasters, fire, and other disasters
• Responsibility for payment of insurance, taxes, and other expenses

Warranty of Habitability

When renting a residential property, there is an implied warranty of habitability. This warranty guarantees that tenants have a reasonably clean, safe, and comfortable place to live that meets all codes. The implied warranty of habitability does not apply to commercial leases, however, unless the lease specifically provides for such conditions. This is another area where consulting an expert in commercial real estate can be beneficial. 

Rent Control Laws

In some areas, residential properties may be rent-controlled. These restrictions do not apply to commercial leases. At the expiration of the lease, the landlord may raise the rent. The only limitations are those provided in the lease agreement. Therefore, consider the conditions for lease renewal and put them in the agreement.

Property Values

Since commercial leases are usually longer in term and may assign property expenses including taxes and insurance to the tenant, a commercial lease can affect the property value. A long-term lease at a fair market value can be a bonus to the buyer and increase the value of the property. Likewise, a long-term lease at a rate that is too low can negatively affect the property value. 

For business owners, terms of the commercial lease also affects the value of the business. If you wish to sell your business, the lease terms can be an asset or liability depending on how well you negotiated in the beginning. If your lease is easily assumable by the buyer, it will be easier to sell the business. You may have no intentions of selling your business when you begin, but you should consider all aspects of the business before signing a lease.

Protect Your Investment with Ironclad Lease Agreements

As a landlord, securing an ironclad lease agreement is crucial to protecting your investment and ensuring a profitable and stable relationship with your tenants. Before finalizing any lease, carefully consider all terms and potential scenarios. Engaging a contract attorney or a commercial real estate broker can provide valuable insights and help you understand and negotiate the lease effectively.

Many lease terms are negotiable, and having an experienced real estate negotiator on your side can secure more favorable conditions and possibly better financial outcomes. An expertly negotiated lease not only protects your interests but also sets the stage for a positive landlord-tenant relationship, which can be beneficial in the long term.

Your lease terms will impact your property’s performance and value for years to come. It's essential to negotiate meticulously to secure the best possible terms. Don't hesitate to seek professional assistance when needed. A well-constructed lease agreement is the foundation for a successful property investment. Contact us today to learn more about crafting and negotiating optimal commercial lease terms.