Basics of Commercial Leases
Overview of Materials:
These written materials were designed to be practice tools that can be implemented in any leasing practice. For most of the topics discussed in this paper, there are two parts. The first part is example language that might actually be found in a Landlord form of Lease. That language has been revised to incorporate changes that a tenant might desire, with those changes being reflected in the example language as blacklined text. Most of such example language is for retail shopping center leases; however, in most cases, it can be easily adapted for use in other types of leases. The second part is a brief introduction to the topic and/or a description of what the quoted Lease language seeks to accomplish and commentary on key points addressed or that should be considered in connection with the topic.
I. Overview Of Commercial Leasing
A. What is a Lease?
1. Real property interest
A lease is a real property interest under which one party to the lease, the landlord, grants to the other party to the lease, the tenant, the right to occupy a defined geographic area, the premises, exclusively. The tenant’s interest is referred to as a leasehold interest, while the landlord’s remaining interest is referred to as a reversionary interest or a reversion.
2. Alternatives to leases—easements, licenses, management agreements
Easements. An easement is a real property interest that entitles the holder of the easement (called the dominant estate holder) to use the property of another (who is called the servient estate holder) for a specific purpose and, usually, for a limited time. An easement is distinguished from a lease in that the servient estate holder usually retains the right to use the property over or under which the easement runs and, thus, an easement is not usually exclusive. Most commercial leases contain, either explicitly or, more commonly, by implication, easements over the common areas of the applicable project to permit access, parking, installation of utilities and other uses of the common areas by the tenants of the project.
Licenses. A license grants the licensee the right to occupy a defined geographic area. However, a license is not a real property interest and, as such, historically did not entitle the licensee to be put back in possession of the licensed space if the licensor interfered with such licensee’s use of such space. Historically, a licensee’s sole recourse was an action for damages. However, the modern trend in other jurisdictions (which has not been ruled upon in Nevada) is to grant specific performance of licenses, thus effectively converting these types of agreements into de facto real property interests. The effectiveness of the distinction is further undermined by existing Nevada case law that makes it very difficult to draft an agreement such that it would qualify as a license, as opposed to a lease. See Sportsco Enterprises v. Morris, 112 Nev. 625 (1996); Department of Commerce vs. Carriage House, 94 Nev. 707 (1978) (not a license because irrevocable and transferable). Accordingly, if a waiver of real property interests and limitation of remedies to a claim for damages is desired, the best practice is to provide for that expressly in the agreement.
Management Agreements. Management agreements are increasingly used to induce highly-desirable retail and restaurant tenants who wish to take on no real estate risk to nonetheless occupy space in a project. Under a management agreement, a project owner hires a manager to manage a certain space or amenity within a project for a defined term. The manager typically invests little in the build out of the space it is to manage and is typically reimbursed for all of its expenses. The manager under such an agreement is typically paid a management fee equal to a percentage of the revenues from the space or amenity it manages. In addition, the manager typically receives an additional incentive fee if the applicable space or amenity performs better than expected. Thus, while the manager will typically share in the up-side under such a deal, because its investment is small, the manager typically faces little of the down-side risk if the project turns out not to be successful.
Each of the foregoing lease alternatives might work better than a traditional lease depending on the deal that has been struck and the intended relationship between the owner and the occupant.
B. Lease economics
1. Minimum/base rent
Tenant agrees to pay, at the times and in the manner herein provided, the Base Rent, Percentage Rent and Additional Rent specified herein (collectively, “Rent” or “rent”), without offset, deduction, counterclaim, prior notice or demand, or abatement, except as expressly set forth in this Lease, for the use and occupancy of the Premises during the Term. All Rent shall be paid by Tenant to Landlord at the address of Landlord set forth in Section or to such other payee and/or at such other place as may be designated from time to time by notice from Landlord to Tenant.
Commencing on the Rent Commencement Date, Tenant shall pay, in advance on the first day of each calendar month during the Term, Base Rent specified in the Section above, in equal monthly installments. However, if the Rent Commencement Date is not the first day of a calendar month, the first payment of Base Rent shall be paid on the Rent Commencement Date and will be a prorated amount based upon the applicable Base Rent amount and the actual number of days in the first partial calendar month of the Term. The Base Rent amounts set forth in Section will be proportionately increased or decreased on a daily basis for any Lease Year that includes more or less, respectively, than twelve (12) full calendar months.
In a lease transaction, the tenant’s primary goal is to secure the use of the specific piece of real property it has bargained for. The landlord’s primary goal is to receive income or rent from the space being leased. The principal components of that rent are the minimum or base rent component (which is referred to in these materials interchangeably as base or minimum rent) and, depending on the particulars of the deal, the percentage rent component. Additional rent components are present in so-called “triple net” leases. Those other rent components are, at least in theory, merely to protect the sum of the minimum or base rent and the percentage rent as landlord’s “real return” or “net rent” and are not themselves intended to be profit centers for the landlord.
It is important to both the landlord and the tenant that the minimum rents be defined either as fixed numbers or so that they can be easily calculated. If the minimum rents are to be based on the floor area of the premises, it is important to include a definition of how that floor area will be measured; to specify the amount, if any, by which the measured floor area may vary from the estimated floor area (if the area of the premises cannot be measured at the time the lease is signed); to provide for re-measurement within some period if either party disagrees with the other party’s measurement; and to specify whether the measured floor area is to be increased by a load factor. (DRAFTER’S NOTE: The application of a load factor to increase the measured floor area is sometimes referred to as “grossing up”. However, I use that term in another way below and throughout this paper. So, to avoid confusion, I will not use that term in this paper to describe the method by which the floor area is increased for purposes of calculating rent. It will refer, in this paper, only to the means by which occupancy-related expenses are increased for comparison purposes, as described below.) Those matters are all discussed more fully below in Section 4(b).
2. Operating expenses and other pass-through costs
a. Net lease
Commencing on the Rent Commencement Date, Tenant shall pay to Landlord Tenant’s Share of Common Area Costs in the time periods and manner set forth in this Section . Landlord shall notify Tenant from time to time of Landlord’s estimate of Tenant’s Share of estimated Common Area Costs. From and after the date of any such notice, Tenant shall pay to Landlord Tenant’s Share of estimated Common Area Costs monthly, in advance, on or before the first day of each month. For the purposes of this Section , “Tenant’s Share” means a fraction, the numerator of which is the floor area of the Premises (excluding Tenant’s service yard, trash enclosure and Patio Area) and the denominator of which is the aggregate as-builtleasable floor area of all space in the Shopping Center which is occupied by tenants as of the first day of the applicable Lease Year, as measured and determined by Landlord. Notwithstanding the foregoing, where Common Area Costs are incurred for goods and services benefiting only a subset of Shopping Center tenants (e.g., where only certain tenants participate in trash removal, janitorial or other services), Landlord shall have the right and option from time to time to adjust Tenant’s Share of Common Area Costs in accordance with a reasonable scheme of allocation taking into account the extent of use of such goods and services by Tenant in comparison with all others using such goods and services, and any such determination made by Landlord shall be final and binding on Tenantthe Shopping Center. If, for so long as, and to the extent that any occupants in the Shopping Center shall be obligated to, and shall, operate, maintain and repair anya fairly allocable portion(s) of the Common Area (“Excepted Common Area”) pursuant to agreement(s) between or among Landlord and such occupants, then Landlord shall not have responsibility for such Excepted Common Area (to the extent of any such occupant obligationsactually maintains the Excepted Common Area to the standard required under this Lease) and “Common Area Costs” shall refer only to the Common Area Costs exclusive of costs associated with such Excepted Common Area (to the extent of such occupant obligations). Landlord also shall have the right and option from time to time to adjust Tenant’s Share of Common Area Costs to include the floor area of any Excepted Common Area Costs and any such determination made by Landlord shall be final and binding on Tenant.
FollowingWithin ninety (90) days following the end of each calendar year, Landlord shall submit to Tenant a statement (the “Annual Statement”) containing (a) Tenant’s Share of Common Area Costs for the subject calendar year, (b) the total amount paid by Tenant for Tenant’s Share of estimated Common Area Costs for such year and (c) the amount of any resulting balance due to Landlord or overpayment made by Tenant on the basis of a comparison between Tenant’s Share of estimated Common Area Costs and Tenant’s Share of actual Common Area Costs for the period covered by such statement. If such Annual Statement reflects that Tenant underpaid Common Area Costs for the prior calendar year, Tenant shall pay to Landlord the amount of such shortfall within tenthirty (1030) days after the date the Annual Statement is delivered to Tenant. If the Annual Statement reflects that Tenant overpaid Common Area Costs for the prior calendar year, Landlord shall apply the amount of such overpayment against the next due installment(s) of Tenant’s Share of estimated Common Area Costsrent or any other amounts due under this Lease until such overpayment has been exhausted or, if this Lease shall have terminated or expired, within thirty (30) days following the date such Annual Statement was delivered by Landlord.
Landlord shall maintain books and records of Common Area Costs for a period of three (3) years following the end of each calendar year. Upon ten (10) days’ prior written notice, Tenant or Tenant’s accountant shall have the right to audit Landlord's books and records relating to any prior year’s Common Area Costs at Landlord's local office, if one exists, or if none exists, at Landlord’s main offices. If the audit discloses that the total amount invoiced to Tenant after year-end reconciliation for such year exceeds the actual Common Area Costs, Landlord, at Tenant’s option, shall either credit the amount of overpayment towards Tenant’s next due payment of rent or any other amounts due under this Lease, or refund the same to Tenant within ten (10) days after written demand therefor. In addition, if such audit discloses that Tenant has been overcharged by [five percent (5%)] [SAME PERCENTAGE AS THE TRIGGER FOR PAYMENT OF LANDLORD’S COSTS TO AUDIT ANNUAL STATEMENTS OF GROSS RECEIPTS FOR PERCENTAGE RENT, IF APPLICABLE] or more of Tenant’s share of Common Area Costs, then Landlord shall reimburse Tenant for the cost of the audit within ten (10) days after written demand therefor. If such audit discloses that the total amount invoiced to Tenant after year-end reconciliation for such year is less than Tenant’s share of Common Area Costs, Tenant shall promptly pay the difference to Landlord. Landlord’s and Tenant’s obligations under this paragraph shall survive the expiration or sooner termination of this Lease. If property taxes and insurance premiums are otherwise payable by Tenant hereunder, but not included in Common Area Costs, then Tenant’s audit rights pursuant to this paragraph shall extend to such charges as well.
Except as otherwise provided herein to the contrary, “Common Area Costs” means the total costs and expenses paid or incurred by Landlord, its property manager, and their respective agents for (a) operating, managing, administering, maintaining, equipping, repairing and replacing all or any part of the Common Area (and any installations in, on, under or over the Common Area), (b) Landlord’s insurance pursuant to Section , (c) Landlord’s repair obligations pursuant to Section , (d) Real Estate Taxes, (e) taxes on the personalty within and/or comprising the Common Area and (f) all other costs and expenses relating to the Common Area including, but not be limited to, the following: The total costs and expenses paid or incurred in cleaning, planting, replanting and maintaining the landscaping of the Common Area; the costs incurred in connection with the procurement of insurance and reasonable reserves for deductibles and any self-insured retentionLandlord is required to carry hereunder; all maintenance and repairs; repainting; rental and maintenance of signs and equipment; purchase and display of seasonal decorations; any public utility or governmental charges, surcharges or costs levied, assessed or imposed upon Landlord or incurred by Landlord pursuant to, or in compliance with, any governmental regulations; lighting; sanitary control; removal of snow and ice, trash and other refuse; maintenance, repair and replacement of light fixtures (including replacement of tubes, ballasts and lamps); maintenance, repair and replacement of the HVAC serving the Shopping Center, maintenance, repair and replacement of mechanical equipment; fire/life safety systems and security alarm systems; maintenance, repair, replacement, and cleaning of structures, including floors, ceilings, roofs (including the depreciation of the above-mentioned improvements), roof skylights and windows; repair, maintenance, replacement and depreciation of the parking areas, including repaving and restriping of the paved areas; non-refundable contributions toward one (1) or more reserve funds; repair and/or replacement of water lines, electrical lines, gas lines, sanitary sewer lines and storm water lines; all electrical, water, sewer and other utility charges for utilities serving the Common Area (including any onsite and/or offsite sanitary treatment plants serving the Shopping Center and all pipes leading to and from the same); the cost of personnel to implement such services; all costs and expenses (including wages, salaries, employee benefits, unemployment insurance and social security payments) relating to the employment of all onsite personnel, including Landlord’s property manager, promotional and development personnel and other onsite personnel utilized in connection with the operation, maintenance and repairs of the Shopping Center; operating costs and maintenance costs for the property management offices in the Shopping Center; the costs incurred in complying with governmental regulations (exclusive of any occupant’s premises), whether done voluntarily or by mandate of governmental or quasi-governmental authorities; the costs incurred in complying with changes after the date of this Lease in the Americans With Disabilities Act of 1990, as amended from time to time, with respect to the Common Area; fees or charges payable to any homeowners’ and/or retail and business associations formed pursuant to recorded agreements to which this Lease is subject; personal property taxes, sales and use taxes on material, equipment, supplies and services; fees for required licenses and permits; fire, security and police protection; public address system(s); [DELETE IF TENANT WILL HAVE ITS OWN RESTROOMS IN ITS PREMISES:] public toilets; reasonable straight-line depreciation of, and all rental charges for, machinery and equipment to the extent used in the operation, maintenance and repair of the Common Area; and the costs incurred for supplies, tools, materials and labor to the extent used in connection with the operation, maintenance and repair of the Common Area. In addition, there shall be included in Common Area Costs an administrative charge equalnot to fifteenexceed ten percent (1510%) of the total of all Common Area Costs (excluding expenses for taxes, insurance and utilities) for Landlord’s administrative overhead.