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A Leasing Lexicon

Filed under Office & HR.

Many small business owners begin as home-based and then expand into rented quarters until such a time as they are big enough to purchase facilities. Here's a helpful lexicon for those owners in that "lease or rental" stage.

By the way, there is no real legal distinction between a "lease" and a "rental." In practice, however, rentals generally are considered short-term arrangements (a day, a week, a month), while leases extend for longer periods (a year or more).

If you have decided that you would rather lease your business facility than purchase it, you should familiarize yourself with the following types of leases and terms that are commonly found in commercial leases.

Common Lease Provisions:

Gross lease -- The most traditional type of lease: the tenant pays rent; the landlord pays taxes, insurance and maintenance expenses relating to the property.

Net lease -- Transfers some or all of the expenses that the landlord is traditionally responsible for to the tenant. With a single net lease, the tenant pays rent plus taxes relating to the tenant's portion of the property. Under a double net lease, the tenant also pays its proportional part of insurance premiums. Finally, with a triple net lease (which is often favored by larger businesses), the tenant pays all charges payable under a double net lease, plus maintenance expenses.

Fixed lease -- Provides for a fixed amount of rent over a fixed rental period (term). These types of leases usually seem the least threatening for the small business owner tenant, since you don't obligate yourself today for rent increases in the future.

Step lease -- Provides for set rent increases to take effect at stated times. This will provide you with the peace of mind of knowing what your rental amounts will be for a longer time period, while giving the landlord some protection against rising costs.

Percentage lease -- The landlord shares in your good (or bad) fortune. The lease provides for a fixed amount of rent, plus an additional amount that is set as a percentage of your gross receipts or sales. This may be advantageous for businesses whose income fluctuates a great deal from month to month, but may also involve opening up your business records to your landlord.

Lease term -- Identifies how long the lease will be in effect. If you suspect that you will want to stay at this same business location beyond the initial term, try negotiating the inclusion in the agreement of a renewal option that entitles you to renew the lease for a specified period and a specified rent.

Rental rate -- Tells how much the rent is and when it must be paid, and whether additional charges are due if you fail to pay the rent on time or within a specified grace period. If your business experiences seasonal or irregular sales activity, try negotiating a flexible rental rate that corresponds to the changes in your cash flow.

Escalation clause -- Provides for increases in rent over a specified time period. The escalations can be fixed or determined with reference to an outside factor, such as increases in the landlord's operating costs, increases in a cost index (such as the consumer price index), or increases in the tenant's gross receipts or sales.

Maintenance -- Specifies who is required to maintain which portions of the building and land. If you are responsible for maintenance, the lease should say whether you can contract with anyone of your choosing to provide these services, or whether the service providers have to be approved by the landlord.

Competition -- In a lease of retail space, such as a store in a shopping mall, there may be restrictions placed on the landlord's right to lease nearby space to businesses similar to your business. (If there are not, you should consider pushing for such a provision.)

Subletting -- Spells out whether, and under what conditions, you are entitled to sublease the premises to another. Remember, if you sublet the property, you normally will still be liable for paying the rent if the subletting tenant does not pay.

Improvements and modifications -- Identifies whether you have the right to make improvements or modifications to the facility so that it better suits your needs.

Taxes -- Specifies who is responsible for the real property taxes.

Insurance and liability -- Fixes who is responsible for casualty and liability insurance and how much coverage must be carried.

Renewal option -- Specifies whether you have the option to renew the lease when it expires, and if so, specifies the amount of rent to be paid (or how the rental amount is to be determined) in the future. A renewal option can protect you against an unreasonably large rent increase when your first lease term expires.

Purchase option -- Tells whether you'll have the right to purchase the facility at the end of the lease term, and if so, at what price.

Destruction or condemnation -- States whether the landlord is required to rebuild if the property is destroyed. Specifies whether rent will be abated, and whether you can terminate your lease obligations if the facility is totally or partially destroyed.

Landlord's solvency -- Spells out your rights as a tenant if your landlord's mortgage company forecloses on the leased premises.

Tenant "going dark" rights -- A fear of many small tenants in a shopping center is that a major tenant will go out of business or not renew its lease ("going dark"). One approach to this problem would be for you to negotiate a clause that gives you the right to close your store or get a large rent reduction if a major tenant or several other tenants default.

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