Owning commercial properties is an excellent investment, but managing it can also be a lot of work. Some owners prefer to manage their properties themselves, but you may find it makes sense to hire a commercial property manager to help you out once you scale up. When does it make sense to take that next step? We’ll take a look at some of the factors you should consider before making your decision.

Factors to consider

Can you afford to hire a commercial property manager?

There is no set formula for commercial property management fees, but there are several ways that property management companies may charge for their services. For example, they may charge a percentage of the total collected rents. The percentage will depend on the company’s services—the more services, the higher the rate. Or, they may charge a flat monthly management fee for larger buildings and charge any on-site salaries and expenses back to the owner.

Fees may also be higher for properties that require more intense compliance and regulation, such as medical offices or food processing facilities. An older building with outdated equipment may also warrant higher fees as it is more likely to need more frequent repairs. Property managers may also mark up the cost of contractors’ prices by 5% to 15%. Be sure to get a breakdown of costs to get a clear picture of how much you will need to budget for property manager costs. You can find more details on commercial property manager fees here.

Do you have too many properties to manage on your own?

How many properties do you own? Are you able to give each one enough attention, or do you feel like you are always shortchanging at least one property? If you manage multiple properties at once, you could likely benefit from hiring a property manager. The more units you own, the more tenants you handle and the greater the responsibility. Each tenant may also have their own unique lease terms and agreements, making it critical to stay on top of various obligations.

Are you short on time?

Is your office staff working overtime to manage your properties? When was the last time you had a vacation? Hiring a property manager to take care of the day-to-day tasks can free up your time for other things. A property manager is dedicated to servicing properties as a full-time job and has much more flexibility to meet with tenants and perform repair work and other essential tasks.

Do you live near your buildings?

Tenants expect a quick response in the event of an emergency or issue. If you are not able to get on-site quickly, your tenants may become frustrated and angry. It’s one thing to make residential tenants wait for repairs or maintenance, but for commercial tenants, it’s their livelihood that’s at stake. Leaks, plumbing issues, HVAC failures can all lead to a loss of revenue or even a loss of inventory. A locally-based property manager can be dispatched swiftly to sort out any problems in an efficient manner.

Also, consider the amount of time you are spending commuting from home to your units regularly. Even living just 30 minutes away takes at least an hour out of your day, plus the time you spend on-site. Not only will you waste time driving back and forth, but you will also spend more money on gas and incur more wear and tear on your vehicle.

Do you want to hire and manage staff?

You can hire staff to manage your properties, but you may need several different positions to cover the same tasks a property management company can provide. You will also need to oversee those employees, and you’ll need to cover benefits and other expenses incurred by having staff on the payroll. Even if you hire contractors rather than employees, you will need to source out reputable tradespeople and supervise them yourself. Property managers typically have a pool of reliable, vetted contractors that they can call on to provide various services to their clients at any given time.

Do you want to be a landlord?

Does the thought of dealing with evictions, tenant complaints and maintenance issues leave you cold? That’s okay. Not everyone is passionate about dealing with commercial tenants and the responsibilities that come with being a landlord. An experienced property manager is skilled in handling landlord-tenant issues and can do so on your behalf. They are well-versed in enforcing lease terms and legal processes, so you don’t need to be.

So what can a commercial property manager do for me?

Commercial property managers can take care of a variety of services, depending on your needs. Most property owners know that property managers take care of facilities, landscaping, upkeep of parking lots and building repairs. But many of them can offer a lot more than just maintenance.

Here are some types of support a commercial property management company can provide:

Tenant relations

A property management company can actively solicit and screen potential commercial tenants and show units to interested parties. That in itself can save quite a bit of time. In addition, they can field and resolve all inquiries and complaints from tenants, so you don’t have to do so yourself. They will be on the ground, building the day-to-day relationships with tenants, and they will be the first to know of any issues that may need to be addressed. Property managers can also coordinate move-ins and move-outs and handle the legal eviction processes. A good property manager will also provide a tenant retention plan to keep tenants happy and satisfied for the long term.

Lease administration

When it comes time to sign a lease, a commercial property manager can prepare documents and arrange the signing around the tenants’ schedule. They can also manage the different lease terms for each of your tenants. This in and of itself can be worth hiring a property manager, especially if your tenants all have different types of lease agreements and unique terms. They can also negotiate the lease terms to ensure that both parties receive a favourable opportunity.

Rent collection

Complex leases with different rates, due dates and terms, means rent collection becomes more complex, especially in commercial properties with multiple tenants. A professional property management company can set and collect rent on your behalf. They will also handle the associated financial record keeping.

Accounting and financial services

And speaking of record-keeping, another considerable benefit that some companies can offer is full accounting and financial services. Again, these services can be worth the money as commercial real estate finances and annual audits can be quite complicated. From keeping track of expenditures to identifying recoverable and non-recoverable expenses, defining capital costs and CAM charges, it can be challenging to stay on top of your accounting. And accurate financial reporting is essential to your business success. Hiring a company to take care of these responsibilities will help ease your burden.

Legal experience

Experienced property managers also understand landlord-tenant laws and can mitigate risk associated with legal processes around security deposits, terminating leases, safety compliance and more. They will also have knowledge of commercial building codes and construction standards.

Insurance

This is an oft-overlooked area of responsibility because it only shows up when it is too late to correct. A certified commercial property manager will ask about the items a tenant is storing on the property that might not be part of the approved use of the premises. Often employees bring projects to the warehouse to work on weekends with company tools. A drum of used oil leaking into the ground can lead to a surprising amount of environmental liability long after the tenant is gone. Other concerns include overloading warehouse storage, which leads to fire suppression inadequacy, or failing to perform equipment maintenance and premises inspections as required to keep the building owner’s insurance policy in force.

Marketing

A commercial property manager can also advertise and market your property to find the right tenants to fill any vacancies. They are experienced in writing compelling ads and know where to advertise to attract suitable candidates. They may already have a base of potential clients that could be interested in your properties if they are the right fit.

You may not require all of these services, but most commercial property management companies can provide assistance tailored to your specific requirements. The ideal property manager should have a good working relationship with both the tenants and you, the owner.

What are some disadvantages to hiring a commercial property manager?

Cost

Of course, the cost is an obvious disadvantage—if you do it yourself, you won’t have to pay other people. However, it makes sense to pay others who have a strong background and experience in the industry to take care of your investment. Remember—time is money! If you are spending way too much time managing your properties than you would like to, it is worth the expense. Calculate how much an hour of your time is worth, and then calculate how much the property management company is charging you. If the return on investment is high, then it is worth the money.

You may not be aware of day-to-day operations

Going from a hands-on manager to contracting out the services, you may feel disconnected from the daily operations. The idea of hiring a property management company is to relieve you of excess responsibility. However, it is natural to want to know what is going on in your own business. Ask the property management company to provide regular updates (weekly or monthly reports—you decide). Check in with your tenants as well to make sure they are happy with the contractor’s services.

No close relationship with tenants

When you take a hands-off approach to managing your properties, inevitably, you will lose connection with your tenants. The property manager will become their first point of contact, and they will regularly see the property manager depending on the services they are contracted to do. However, this may also be an advantage to anyone who prefers not to deal with tenants directly.

A property management company may handle things differently than you would

If you are very particular about how you want your properties managed, you may be hesitant to hand over the reins to a second party. However, you can interview various companies to find the right fit for your style. Prepare a list of questions to ask and understand what is reasonable within the industry.

You will have to manage the manager

To ensure that your business is running smoothly, you will need to be in constant contact with the property manager. Schedule regular check-ins and request monthly reports to stay well-informed. Ask for cash flow statements, balance sheets, profit and loss statements and any other information that can give you an overview of your financial performance. Read the reports and analyze them for any irregularities.

You may not be aware of critical data

When you step back from the operations, you may not be informed of significant payments or refinancing triggers. Again, make sure you set up a system with the company to contact you when critical financial decisions need to be made. Check to see if the company uses property management software like CRESSblue. If they do, they can easily set you up as a user on the system, so you can keep yourself up to date and informed at all times with automatic owner’s reports.

Bottom line: Hiring a commercial property manager is up to you

While deciding whether to hire a commercial property manager is a personal decision, there are many advantages of doing so. Finding the right company to manage your property can save you both time and money and reduce your stress level. Look for an established commercial property management company with the knowledge and experience to help you get the most out of your investment. To find the best fit for your business, take the time to do your research and thoroughly screen the commercial property management companies. Ask your colleagues for referrals, and look for a company that shares the same business philosophies as you.

The commercial property manager represents your company and should be considered a long-term partner in supporting your business vision. A successful partnership will result in a more substantial return on your investment.

Disclaimer

This article is for informational purposes only and is not intended as professional advice; please consult a competent professional for advice specific to you. This blog is written to stimulate thinking on concepts related to commercial leasing. Please join the discussion with your experiences.

Martin Sommer, CEO, CRESS Inc.

Follow me on LinkedIn

Martin is a founder and the CEO of CRESS Inc., a Canadian SaaS company that automates lease administration and asset management. Martin also manages Karanda Properties Limited industrial portfolio as Director of Operations in all areas of commercial property management, including new development, asset management, capital expenditures, operations, leasing and lease administration of the industrial portfolio. Martin writes about property management workflow and issues. Book Martin to speak at your industry event.

Do you think you know enough to be a master-level property manager? Here’s how to step up your game, reduce your risks and actually turn a profit. We have picked the top three areas where you need to have real skills in order to be successful.

1. It’s a business, and you’re in charge

So you bought an investment property. That means you’re an investor now, right? Possibly. Buying a commercial building can be an investment, but buying and leasing a building doesn’t make you a property manager; it just makes you a landlord. Unlike any other major investment vehicles, real estate isn’t a buy-it-and-forget-it venture. Without understanding and following some key business processes, your investment is likely to underperform and could actually lose you a lot of money. Manage your properties poorly and you could end up in court as well.

So what are the keys to being a successful property manager? Let’s dive in!

Understanding financial investments

Most people understand the simple initial financial analysis. Often, investment property shows cover the basics, which are easy to follow. Additionally, there are plenty of free software tools you can download. Typically, the education stops there.

Asset management

Whether you are a building owner or managing someone else’s property, you need to understand building maintenance, basic construction management and capital expenses. Most commercial leases indicate all major capital expenses are the landlord’s responsibility. An unplanned early capital replacement can make your investment returns drop considerably or even lead to losses. Not making timely building repairs can lead to lawsuits from tenants for negligence and preventable losses.

Business structure

Owning a commercial building is a business. Managing a commercial property is also a business. Even though the owner—or a group of owners—may be the same for both, they are often separate businesses, regardless of whether they are owned independently or deal with each other at arm’s length. There is a common misunderstanding among inexperienced owners and property managers that accounting for the property-holding company and the third-party property management company can be merged. It’s important to keep the two separate and maintain organized, traceable financial records.

Accounting

Business success depends on keeping up to date with your accounting and doing it correctly. With commercial net leasing comes a host of accounting requirements specific to allocating costs to tenants according to the terms of the lease agreement. There’s an excellent overview article here and a more in-depth article here to help you better understand these concepts. Your skills and performance in this area determine most of your value as a property manager. Competence in these fields relies on your expertise in asset management, lease administration and well-structured business relationships.

Build your skilled team

Knowing your business is a considerable challenge! To successfully make money on your commercial property investment requires a wealth of industry knowledge. For example, there is building construction knowledge, legal and accounting expertise, real estate market information and connections to keep current. It’s impossible to gain all the required skills in a short period of time. If you want to build wealth and manage well, you need to build your personal network of trusted business connections so that you have reliable experts you can depend on. Just remember that while you can delegate tasks to your team, you are still ultimately responsible for the operation of the business.

2. Lease administration for property managers

Commercial leases are mostly standard boilerplate clauses that rarely affect anything, right? Wrong. They all mean something significant; that’s why they were developed over time and included on most leases. You need to have a grasp of why those clauses are there and what triggers them. The lease terms are there to provide boundaries to acceptable behaviour from the tenant and the landlord. A good lease works like a flow chart, catching various problem conditions and funnelling the outcomes to predictable results. We covered the key points in more detail here.

Understanding commercial leases allows you, the property manager, to be a better negotiator. Lease clauses were developed over the years in response to situations that appeared in disputes and court cases, and from those, a set of semi-standard lease terms were constructed. They use language tested in courts and guided by case law to interpret those specific phrases. Collectively, these are known as “standard boilerplate” clauses. Boilerplate clauses are terms and conditions included in all lease documents to avoid potential legal cases. They also provide a sense of security to the lease parties. They understand they will have reasonably known outcomes if those situations arise. The trouble with the boilerplate is that it was developed—and used—assuming the future will be reasonably similar to the past. That assumption blew up with the pandemic in 2020.

Here are just a few examples of clauses that need serious rethinking:

Restrictive use clauses

These show up in retail leases all the time. Essentially, they prevent one or more parties from engaging in the sale of certain products or services. They are by definition anti-competitive as they restrict the premises from being used for various banned uses. These are often called “radius clauses” because they apply to a circle around the leased premises with a defined radius or even several radii. The closer the infraction, the greater the repercussions for breaking the restriction.

Restrictive use clauses have one of three principal drivers for their inclusion:

1. If the tenant signing the lease requests them, they are trying to prevent the landlord from leasing space to one of their competitors. The reasoning behind this is explained by game theory and the Nash equilibrium.
   
2. If the landlord requests it from the tenant, there are at least two reasons. One, they have given exclusive rights to another tenant and need to make all new tenants comply with those previously agreed-to conditions. Two, they could be trying to prevent the tenant from taking its business elsewhere within the same proximity. To make sense of this, you’ll need to understand retail rents (coming up in the next section).
   
3. The last type of restrictive use is where the property manager deems the business use to be undesirable. This type is most evident in shopping malls, for businesses such as gyms and service providers. Once forbidden, they now seem to be the saviours of many commercial retail properties.

Restrictive use clauses can cause headaches for property managers

The problems with restrictive use clauses are many. First, unless the tenant is the first in a cluster of retail locations, other tenants may already have restrictive use clauses enacted or may have the freedom to sell the products the new tenant wants to restrict. Second, the way the lists of products are written is often the issue. What appeared to be clearly defined limits when the lease was written becomes muddied when cross-over products are developed. Are those restricted or not? Third, the remedies stipulated in the lease may be very difficult or expensive to collect. This is especially true when the actual damages cannot be quantified, and the lease provisions seem illegally punitive as a result.

If you want to get into this more, there’s an excellent blog here that digs into this much further. Lastly, restrictive uses embedded in many leases can be difficult to remove as perspectives change on what is considered undesirable.

Expansion clauses

These come in a variety of forms: a Right of First Opportunity (ROFO) or a Right of First Refusal (ROFR). These can be one-time, ongoing or time-limited. They can refer to a specific space or any adjacent or nearby space in the same complex. In all cases, they are for the benefit of a tenant and restrict the landlord’s ability to lease the property.

ROFO

A Right of First Opportunity allows a particular tenant to have the first opportunity to expand into some space that becomes vacant. This is generally preferable to a landlord than the other option, a ROFR.

ROFR

A Right of First Refusal allows a tenant to make a last-minute attempt to match a competing lease offer on available expansion space. The prospective new tenant may find that all its negotiation efforts and costs benefit an existing tenant when this right is exercised. Having a ROFR lowers the interest of new tenants in the landlord’s property.

Problems with expansion clauses

Not understanding the implications of expansion clauses can lead to some tough and very costly situations for a landlord and subsequently for the property manager.

First, make sure the lease uses the correct terms. A ROFR is a lot less desirable to a landlord than a ROFO.

Second, make sure the time limits are clearly defined, both for the right itself and the timeframe a tenant has to exercise it. Is it a one-time right? If the tenant uses it, is it gone or can it be exercised repeatedly any time during the course of the lease term when any new space becomes vacant? Can it still be used later for another opportunity if it is refused once?

Third, what happens when more than one tenant has an expansion right over the same space? With ongoing rights, previously spaced tenants may become adjacent to the same open premises.

Finally, what constitutes a matching offer? Tenants are not identical, and a landlord may prefer one type of business over another. Additionally, the property manager may project that a lease with one tenant will be more lucrative, which—all else being equal—makes that offer better than lease rates alone describe.

Operating expenses and caps

We’ve seen all kinds of additional rent capping clauses. Most of them aren’t written well enough to be worth the paper they were written on.

The lease sections on operating costs are often one of the longer ones, but they almost invariably rely on two definitions that aren’t really definitions at all. They split property expenses into “operating costs” and “capital expenses” as if these words have no gray area between them. To an accountant, once these amounts are recorded in the journal, they are either one or the other. But in practice, property managers often see operating and maintenance costs where tenants see capital repairs.

Using two accounting words doesn’t make the definition any clearer to anyone. The best clauses include:

• A schedule that lists specific details about equipment and asset classes
• The type of maintenance or replacement
• Whether it is deemed an operating expense or a capital expense
• Who is responsible for having the maintenance done
• Who pays for it
• How it is paid for
• The amortization period

At least then you have a hope of both parties having the same understanding of cost allocations.

Cost control caps

Precisely because the additional rent is such a practical mess in most leases, lawyers and negotiation teams look to simply cap those operating costs by putting an artificial limit on what the landlord can recover from that tenant. Let’s take a look at the various solutions we have encountered and the problems with each.

The straight-line cap

This is the simplest cap. It can have a variety of forms, from fixed amount annual increases to incremental percentage increases. The laziest implementation is what is known as the “base year” for additional rent. In this case, the net lease specifies a monthly rent, which includes the first year of the additional rent. Base year leases rarely get a proper reconciliation. Likewise, the amount for the base year additional rent is seldom specified in the lease. Moreover, the straight-line method fails to account for times when there are significant maintenance upgrades to the property, such as repainting or regenerating the landscaping plan. It either leads to the property manager missing out on additional rent recoveries or the more likely scenario where the property never gets any significant updates.

Year-over-year versus initial rates

Some leases cap the increases based on the previous year and some base the cap on the initial year. The year-over-year method penalizes the landlord every time they successfully bring in a lower budget, as they are forced to reset the cap lower for the next year. The initial rate method constrains the increases below a line that cannot be exceeded. This results in a fairer cap towards the landlord. Most often, the problem encountered is that the initial rate is rarely included in the lease document, making this cap impossible to enforce.

Controllable expenses

In an effort to negotiate an impasse over the additional rent cap, a common compromise is to insert the words “controllable expenses” into the cap clause language. While this sounds like reasonable language, applying it in practice is anything but. We can likely agree that the property taxes are out of the scope of the landlord’s control. What about property insurance? Winter maintenance costs or liability insurance? In one exercise, about 3% of additional rent was actually discretionary to the landlord. The rest was out of their jurisdiction or controlled by market forces that the landlord couldn’t influence.

Using controllable expenses can lead to complicated accounting procedures. Each of the expenses will need to be classified, applicable caps set and, for each expense class, the initial rate or amount must be recorded. It’s seldom worth the effort. For example, it could cost $1,500 of billable time to calculate a $300 annual savings on the tenant’s additional rent.

3. Understand percentage rents

Every property manager should understand how percentage rents work. Percentage rents are a complex rent calculation method for determining the rent based on a fixed minimum rent and a variable portion based on the tenant’s monthly sales. A percentage rent is rent applied above a minimum base rent and is a percentage of the gross sales that the tenant makes from the premises. The percentage is often estimated and reconciled on a monthly or annual basis and may be averaged over a period of time.

Breakpoints

The percentage rent applies once gross sales meet a certain threshold. The point at which percentage rent is paid is called a “breakpoint” and can either be a natural or artificial breakpoint. If the breakpoint is never met, the tenant is only obligated to pay the minimum rent.

An artificial breakpoint is simply a dollar amount of sales, where a specified percentage of gross sales above an agreed-upon dollar amount is to be paid in percentage rent. For example, if the percentage rent is 25% of gross sales above $25,000 a month, then the percentage rent on $30,000 gross sales is $1,250.

To calculate the natural breakpoint, simply divide the base rent by the established percentage. The logic behind the natural breakpoint is that a retailer should only pay the percentage rent on sales over and above what is required to pay the minimum rent.

Purpose of the percentage rent

The purpose of percentage rent is to tie the tenant’s success to the amount of rent it pays and, therefore, to the landlord’s success. From the tenant’s perspective, it functions as insurance against hard times, lowering the rent it must pay if sales go down. From the landlord’s perspective, if the tenant does well, the landlord can cash in on that success too.

Pitfalls of percentage rents

While percentage rents seem to benefit both the tenant and landlord, there are some risks associated with this method.

Online shopping

The most common issue in recent times has been the definition of which type of sales constitute the basis of the percentage rent calculation. Do online sales count? What about online sales that are picked up in-store? How should product returns be handled? What if the item was purchased online, picked up in one store but returned to a different store? Online sales could potentially have much lower margins for the retailer than in-store-only items. The possible scenarios get out of hand very quickly. And the rapid nature of change online makes predicting and accounting for changes years into the future impossible to record adequately in a lease document.

Property valuations

Lenders use property valuations for mortgage limits based on the cash flows for the property. Rental rates that allow for monthly variability will result in lower valuation for the property. This is particularly true if there is currently an economic downturn. Property owners may find there is less financing available to them for properties with percentage rent leases.

Cash flows

With percentage rents, the rental rates lower immediately on slower sales instead of in the next leasing cycle. Pandemic-related closures resulted in immediate loss of cash flows for retail property owners. Using a simpler method of fixed rent increases provides greater certainty.

Increased accounting work

Tracking each tenant’s sales, returns and losses for each rent period for multiple categories of goods is a time-consuming process. A portion of the rent paid in advance and a portion paid retroactively further complicates the monthly rent reporting. Receiving the sales information from the tenant in a timely manner can be another problem. As well, the landlord may need access to confidential information if an audit of the tenant’s sales figures is necessary. Unless they are large tenants with sales numbers to justify the additional accounting work, it’s best to use a simpler method. That is the primary reason that percentage rents have nearly disappeared from common use.

The bottom line

When working as a property manager, remember you are in an ongoing business relationship with your tenants. Your success in business depends on the success of your tenants. The property owner’s success depends on the ability to manage the properties (whether privately owned or financed). The owner only receives a return on their investment if the properties are profitable. More than ever, we are all in this together.

Be reasonable

There’s an old adage that says, “When you go to court, only the lawyers win.” Therefore, it is in your own best interest to be reasonable in your business deals. Seek to foster an atmosphere of cooperation with your tenants. In fact, you are on the same side of the table when you face the property owner. It’s often not worth the time to track and calculate arbitrary limits when spending time clarifying the underlying concerns is the far better solution.

Be flexible

If the pandemic taught us anything, it is that the past performance doesn’t predict the future. Avoid unnecessarily encumbering either party for low probability events, questionable gains or because “we always have those clauses in every lease.” Don’t try to capture every low probability scenario. Instead, work out the major issues and put a resolution mechanism in place for dealing with the unforeseen ones. This is especially relevant for smaller landlords and tenants where legal costs will quickly make combative approaches unprofitable.

Be transparent

The best way to deal with uncertainty is to be able to trust your business partners. Trust requires clarity and transparency. CRESSblue Commercial Property Management software is specifically designed to accurately record transactions, automatically break down costs and be transparent to tenants and owners alike with audit trail reporting on every transaction. The easiest way for a property manager to achieve their goals is by using CRESSblue Commercial Property Management.

Disclaimer

This article is for informational purposes only and is not intended as professional advice; please consult a competent professional for advice specific to you. This blog is written to stimulate thinking on concepts related to commercial leasing. Please join the discussion with your experiences.

Martin Sommer, CEO, CRESS Inc.

Follow me on LinkedIn

Martin is a founder and the CEO of CRESS Inc., a Canadian SaaS company that automates lease administration and asset management. Martin also manages Karanda Properties Limited industrial portfolio as Director of Operations in all areas of commercial property management, including new development, asset management, capital expenditures, operations, leasing and lease administration of the industrial portfolio. Martin writes about property management workflow and issues. Book Martin to speak at your industry event.

Whether you’re a first-time investor or a veteran looking to brush up on your commercial leasing terms, we’ve got you covered. This article defines the various lease agreements and industry jargon to help you better understand what they mean to landlords and tenants – and the relationships between them. In the simplest terms, a lease agreement is a document that lays out the allocation of risk and responsibility for the use of property in exchange for money. Now, let’s dig into the terms and definitions.

Gross lease vs. net lease

There is no one-size-fits-all approach to commercial leasing. Lease agreements between landlords and tenants can take many different forms. To start, let’s define the difference between a gross lease and a net lease.

Gross lease

A gross lease is a lease in which the landlord pays all (or most) expenses associated with owning and operating the property. This ‘all-inclusive’ lease agreement is sometimes perceived as the most tenant-friendly lease type as the tenant can budget for a regular flat fee. However, the gross lease may be higher than necessary in order to protect the landlord from cost increases over time.

Most often used in office buildings, industrial and some retail properties, a gross lease eliminates tenant responsibility for the variable expenses associated to the property. Typically, gross leases are easier for small spaces, very short lease terms or unsophisticated tenants where convenience is paramount. However, there are instances when an overconsuming tenant may be on the hook for overage charges. For example, if a tenant exceeds electricity consumption beyond building standards, additional fees are often charged back to the tenant.

So, what is a net lease?

A commercial net lease, or N lease, is a lease agreement in which the tenant pays base rent plus additional expenses such as insurance premiums, maintenance costs and property taxes.

From a landlord’s perspective, the advantage of a net lease is that it offsets the variable costs of property ownership to the tenant. For example, if property taxes increase by 2% next year, it is the tenant’s responsibility to cover the additional rate in a net lease arrangement.

At the same time, net lease agreements can also be risky for the landlord if the tenant is responsible for making all the net lease payments. Let’s imagine the tenant fails to keep their property tax payments up to date; this may result in additional fees and fines that the landlord is responsible to pay. Even public utilities are often charged against the property title if the tenant defaults on the payments, resulting in an additional surprise for an unaware landlord. Therefore, most landlords prefer to file their own property taxes to ensure payments are made on time and in the correct amount.

Net lease tenants typically have the advantage of lower rental rates than that of a comparable gross lease. This is true even when factoring in the taxes and other operating expenses. Since the tenant is accepting a higher risk level, the compromise is that the commercial leasing landlord accepts a slightly lower income in exchange for consistency.

Single, double and triple net leases

Let’s dive deeper into the different types of net leases. As a disclaimer, it’s important to note that net lease terms are often used interchangeably. Commercial leasing landlords and tenants will want to avoid making any assumptions based on how a lease is characterized. Lease documents should always be carefully reviewed to understand the obligations and the expenses for which each party is responsible.

Where net leases can differ is dependent on how the operating costs and expenses are allocated. This presents landlords and tenants with an array of choices for various scenarios (we’ll cover more about operating costs a little later in the article).

There are three basic types of net leases: single, double and triple net.

Single net lease

Single net lease properties are the least common of the bunch. In these leases, the tenant is responsible for paying base rent, plus all or a portion of the property taxes. In these leases, the tenant becomes responsible for the property taxes, whereas all other expenses such as operating costs, maintenance costs and insurance costs are managed by the landlord. Usually, tenants with a single net lease pay a lower base rent because of the added responsibility of property taxes.

Double net lease

Double net leases, also known as net-net or NN leases, is an agreement in which the tenant pays the property taxes and insurance premiums in addition to the base rent. All other expenses, such as maintenance and repairs, are paid directly by the property owner. Most commonly used in commercial real estate like shopping malls or expansive office complexes, landlords will charge double net lease expenses proportionally to the size of the leased space. A single or double net lease may also be called a semi-gross lease.

Triple net lease

A triple net lease removes the landlord from the equation entirely, as tenants pay most if not all property expenses. Much different than the ‘all-inclusive’ gross lease agreement, under a triple net lease the landlord is ‘hands-off’ as the tenant is responsible for all property taxes, insurance, maintenance and repairs in addition to the base rent.

Historically, triple net refers to leases where one tenant rents an entire commercial building and pays all property expenses for a longer-term (ten years or more). As leasing practices have evolved, the term triple net lease now also describes leases for a multi-tenant building where each tenant pays its proportionate share of expenses.

Single-tenant and multi-tenant leases

By now, hopefully, we have demonstrated that commercial real estate can offer opportunities in a variety of arrangements. Whether an investor is looking to establish a single-tenant net lease property or a multi-tenant net lease property, both types of options have their pros and cons.

First, let’s enhance our understanding of single-tenant and multi-tenant net leases.

Single-tenant net lease

A single-tenant net lease is a rental agreement between the one sole occupant of a space and its owner or landlord.

Due to their simplicity, single-tenant net leases are often a good fit for first-time commercial leasing investors. With only one tenant to attend to, the property investor encounters less of a burden in comparison to managing the needs of multiple tenants. Imagine a scenario in which an investor has a single-tenant agreement with a triple net lease; the landlord could be alleviated of almost all property obligations.

Of course, investing in a single tenant property heavily relies on the quality of one sole tenant. The investor’s primary source of income significantly depends on the occupant’s financial contribution. If the tenant unexpectedly vacates, there could be detrimental financial and maintenance implications the longer the property remains unoccupied.

Multi-tenant net lease

Comparatively, in a multi-tenant net lease the odds of total vacancy are very low. A multi-tenant net lease is a lease between a landlord and a tenant where there are also other lease agreements within the same building complex, typically in a larger commercial retail property.

Investors might favour a multi-tenant property because they prefer to manage several units simultaneously instead of several individual projects. Contrarily, it may increase duties as multi-tenant buildings usually require more structural maintenance and repairs, and additional provisions to consider.

Retail lease agreement: common clauses

Retail lease agreements have various provisions to ensure both landlords and tenants are protected. The following terms are just the tip of the iceberg when analyzing the multiple permutations that can inform a retail lease agreement.

Retail anchor tenants

For many retail tenants, success is dependent on their neighbours. Anchor tenants is a term that refers to the key retailers that play a critical role in bringing crowds and human traffic to malls. Landlords are very likely to provide favourable rental rates and terms to anchor tenants, as they help sustain the business of smaller retailers.

In some leases, an anchor tenant agrees to a “continuous occupancy clause” which is a provision in a lease that requires the tenant to stay open during specified hours and operational throughout the period of tenancy.

Strength in numbers

Another negotiable lease agreement provision for retail tenants is the “go dark” clause. Under the go dark clause, tenants can stop operations in an unprofitable space while still paying rent for it. A tenant may choose to go dark for a few hours, days or weeks. They may wish to focus their resource on more profitable locations, or they may need time to overhaul the space decor.

Consequently, if anchor tenants or multiple anchor tenants leave the retail space, it is likely to result in a drawback of foot traffic and less business for the remaining tenants. Thus, the need for a co-tenancy clause. A co-tenancy clause is a retail lease provision which provides the tenant with protection in the form of reduced rent to compensate for traffic loss.

A provision that is advantageous for both property owners and tenants is known as “percentage rent.” Simply put, percentage rent is additional rent paid by the tenant based on a percentage of gross sales. The idea behind percentage rent is to give the owner the opportunity to negotiate the placement of a retailer in exchange for a percentage of their sales. If a tenant is experiencing periods of slower sales, the rent adjusts lower to accommodate the lower cash flow the tenant is experiencing. It provides a method to make the rent representative of the value the space has to the tenant over a wide range of profitability experiences.

Percentage rent, operating costs, capital costs and CAM fees

Now that we have a baseline understanding of the various lease agreements and clauses, we’ll conclude by exploring different lease expenses and how they are calculated.

How is percentage rent calculated?

With a percentage rent lease, a tenant must first pay a minimum rent. Once gross sales surpass a specified mark known as a ‘breakpoint’ the tenant is required to pay the owner a certain percent of every additional dollar in sales as additional rent. The percentage rent is often estimated and reconciled on a monthly or annual basis and may be averaged over a period of time. In some cases, the percent is industry standard and isn’t subject to much negotiation.

Natural vs. artificial breakpoint

The breakpoint is an important negotiated method, as there can either be a natural or artificial breakpoint.

A natural breakpoint is calculated by dividing the base rent by an agreed percentage.

Whereas, an artificial breakpoint may be determined by the bargaining power of the parties or specifics of the transaction. For example, a landlord may negotiate a breakpoint below the natural breakpoint, while a tenant with more clout may be able to negotiate a higher breakpoint.

Operating costs

Operating costs are common expenses that are paid frequently as they are necessary to operate and maintain a property. As noted throughout the article, operating expenses are often tacked onto a lease agreement in various forms. Some examples of operating expenses include property taxes, property insurance, maintenance expenses, utilities and administrative expenses. Operating costs do not include capital expenditures, debt or amortized cost recovery.

Capital costs

Unlike operating costs that are frequent and relatively low-cost, capital costs in a commercial lease are intermittent, expensive upgrades to the property that provide long term value. Some examples of capital costs include the installation of a new security system, a new parking lot or HVAC repairs.

These expenses are paid by the landlord and then amortized over a period of years. Some leases allow these costs to be recovered under specific conditions and over a period that is specified in the lease agreement. Typically, the amortized amount is charged monthly along with the rent and additional rent on an invoice for a specified period after the first replacement has occurred.

Common area maintenance

Common area maintenance charges, also known as CAM expenses, are the fees paid for the upkeep of areas designated for use and benefit of all tenants in a shared space. CAM expenses are common in multi-tenant lease agreements such as shopping centers and can include charges for parking lot maintenance, snow removal, utilities and more.

There are two basic calculations for CAM fees: variable CAM fees, where the amount charged to the tenant can vary based on expenses that may fluctuate monthly, and flat CAM fees, where the fees are a fixed amount.

CAM cap refers to the maximum amount for which the tenant pays its share of common area maintenance costs, and the owner pays for any CAM expenses that exceed that amount. For larger shopping centres, the anchor tenants may negotiate a flat CAM rate or CAM cap, and the remainder of the tenants will proportionally pay the balance of the CAM charges.

Optimal commercial leasing

The best way to understand the ins and outs of commercial leasing and manage optimal lease terms is to work with a team of experienced professionals, including realtors, lawyers, accountants and tech partners. When it comes to calculating complex multi-tenant expenses, leveraging property management software like CRESSblue can help commercial leasing landlords automate cost-recovery calculations for more accurate and professional results. CRESSblue is designed and backed by experienced commercial real estate professionals. This specialized net lease software efficiently handles custom leases for various unique circumstances – from multi-tenant to single-tenant, or any combination in between.

Disclaimer

This article is for informational purposes only and is not intended as professional advice; please consult a competent professional for advice specific to you. This blog is written to stimulate thinking on concepts related to commercial leasing. Please join the discussion with your experiences.

Martin Sommer, CEO, CRESS Inc.

Follow me on LinkedIn

Martin is a founder and the CEO of CRESS Inc., a Canadian SaaS company that automates lease administration and asset management. Martin also manages Karanda Properties Limited industrial portfolio as Director of Operations in all areas of commercial property management, including new development, asset management, capital expenditures, operations, leasing and lease administration of the industrial portfolio. Martin writes about property management workflow and issues. Book Martin to speak at your industry event.