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Real Estate Law | January 2014

Beware of Total Costs in a Commercial Lease

In a commercial real estate lease, be alert to base rent, tenant improvements, percentage rent, CAM charges and tenant promotional organizations

See related article, Commercial Lease Expenses: Be Careful of the CAM Charges

You have decided to take the entrepreneurial plunge, chase the American dream and open your own business. Your financing is in place, your business connections are established, and you hire a commercial real estate broker to find just the right location. He does his job and presents you with a “standard lease” with a base rent of $5,000 per month for five years. All you have to do is sign and get to work.

Wait – what?

Let’s take a long, hard look at that lease. First, understand that this lease obligates you to $300,000, probably personally, and is going to dictate how you run your business for that entire time. Plus, you noticed the $5,000 monthly base rent, but did you look to see what other financial obligations you just assumed? Let’s look for other bears that may be hiding under the bed.

Base Rent

This we already know about. It is the advertised price – the “rack rate,” if you will. But what exactly does it mean, and what does it include? For example, does it include reserved parking? (Many landlords charge separately.) Is there a clause substantially increasing the rent after the first year or some other introductory period?

Tenant Improvements

Unless you were lucky enough to locate premises that were already perfect for your business, some degree of construction is going to be necessary to ready the space for your use. Who is going to pay for this potentially significant expense? Are you supposed to pay out of pocket and then receive a credit against future rent (or not)? Does the landlord pay? Can you pick the contractor, or does the landlord’s guy do it? What restrictions are there on design?

Percentage Rent

This is somewhat uncommon, but it means what it sounds like. The landlord gets, as additional rent, a percentage of the revenue you generate every month. Who pays for the accounting? How is “revenue” defined (e.g., gross revenue, gross profit, net profit)? Is there a minimum you have to pay if you have a slow month?

Common Area Maintenance (CAM)

Most commercial leases require you to pay your “pro rata share” of “common area expenses.” But what is your pro rata share? Can it change over time”? Is there a minimum? A maximum? And what expenses are included? This area is one of the largest sources of landlord/tenant disputes. We will follow up in the next few months with an article devoted to an analysis of CAM charges and how they are allocated. For now, suffice it to say you really need to know the answers to those questions.

Other Maintenance Expenses

Aside from CAM charges, which are shared, you may be responsible for certain expenses of the overall project that are yours alone to pay. A common and expensive example is the maintenance of all HVAC units serving your particular unit. Other examples include separately metered utilities.

Tenant Promotional Organizations

Some leases require you to belong and contribute to a separate group promoting the overall center on behalf of all tenants. These groups advertise and conduct center-wide promotions (carnivals, car shows, etc.). They can be helpful; they can also be expensive.

Bottom Line

You are eager to get your business up and running, and the sooner you sign the lease, the sooner you open. But the expenses mentioned above can dwarf the base rent and drive your budgeted rental expense to two or three times what you thought it would be. You do not care whether something is called “base rent,” “CAM charge” or “improvement pass-through.” You do care about the size of the check you will hand the landlord each month. There are answers and negotiations for all of these issues, and you need to make an informed decision. If you remember nothing else, always bear in mind that there is no such thing as a “standard lease.”