“Hello, I am looking for 2,000 square feet for my company. Do you have anything?”
“Sure! We have 2,000 square feet in Pioneer Park for $6.75/sf + NNN (triple net). We also have some great flex space for $8/sf GROSS in the Warehouse District. Interested?”
“What’s triple net (NNN), and how much is that a month? What’s flex space? And what does gross mean?”
Ever look for office space and think people are speaking another language? How do you know what is what, to compare apples to apples?
Many times when someone needs new office space or is looking to move, they are not aware of their options—or what to ask. They probably moved into their existing space because it fit their immediate needs and budget, but it may no longer fit their current needs or growth plans. They need to look at space from a different point of view. But where do they start?
Let’s Start with the Basics: NNN or Gross? And What’s the Difference?
NNN lease, or “triple net” lease, is where the tenant assumes all expenses for operating a property, including both fixed and variable expenses and any common area maintenance that might apply. The landlord, however, is responsible for structural repairs. Gross lease is where the tenant pays a set “gross” amount for rent and the landlord pays all real estate expenses.
These are the two extremes, but there are many hybrids in between: modified gross lease, net lease, net net lease, absolute net lease, absolute net bond lease, and many more. So how do you know what’s included? Let’s ask some basic questions…
Is This an NNN Lease or a Gross Lease?
If it’s an NNN lease, ask what the NNN rent is. This is usually not given when an agent gives the base rent. They will usually say it’s “$8/sf triple net or NNN”—which means there are additional costs above and beyond the $8/sf. You will want to know what the NNN rent is currently, as well as what it has been historically.
If it is an NNN lease, what is included in the NNN? Property taxes, building insurance, and common area maintenance? Are there additional items? You will also want to confirm that any common maintenance areas are on their own separate “house” meter or are able to be monitored separate from any tenant space.
If it is a gross lease, what is included in the gross lease amount? Are utilities included? Usually in a true gross lease, the utilities and all expenses incurred by the tenant are included in the base gross
Note: True gross leases are rare. There are a lot of versions of modified gross leases, where they combine the NNN expenses and the base rate to come up with a gross lease amount; however, the tenant is responsible for their own utilities. Thus it would be a modified gross lease, not a true gross lease.
Now that you have the numbers and understand the structure of lease…
How Do You Calculate How Much You Will Have to Pay Per Month?
For an NNN lease: Let’s say you have 2,000 square feet at $7/sf NNN, where the NNN is $3.50/sf. You would multiply 2,000 by $10.50 ($7/sf base rent + $3.50/sf NNN rent), equaling $21,000—the amount of rent you will pay in a year. Dividing $21,000 by 12 (months) gives you $1,750 monthly rent, plus whatever business expenses you may have, such as utilities, internet, etc.
For a gross lease: Let’s say you have 2,000 square feet at $11/sf GROSS. You would multiply 2,000 by $11/sf and divide by 12 months—a monthly rent of $1,833.33, plus whatever business expenses are not included in the gross rent amount.
Special note on NNN leases: The NNN payment is usually paid on a monthly basis, so they are basically escrowed. At the end of the year, there is a reconciliation, where they compare what you have paid in for NNN rent with what was paid out for NNN expenses. If there is a balance due, the tenant must pay the shortfall. If there is a surplus, the landlord and tenant can decide to adjust the NNN rent for the next year, or simply refund the surplus funds to the tenant. This is the main reason to ask how the NNN has been historically—you always want to have a little bit saved at the end of the year, just in case you have to make an additional payment.
What is the Landlord Providing for the Base Rent Amount?
There are a few terms you will hear at this point in time, so let’s define them:
As-is, where-is: Basically, what you see is what you get. The landlord is not going to do anything to the space for the quoted rate.
Vanilla box, also known as white envelope: This is where all the exterior walls will have drywall, taped, sanded and painted/primed, finished ceiling, finished flooring—basically a finished shell, with HVAC and all electrical functioning properly. They may have restrooms as well in the space.
Cold dark shell: The space is rough and wide open. It may not have HVAC or permanent lighting, and rarely has finished restrooms. They may have left out some of the concrete and stubbed up into the space, but nothing is finished. When you hear “cold dark shell,” think rough—very rough.
Is There Any Tenant Improvement Allowance, or “TI”?
A tenant improvement allowance (TI) is a sum of money the landlord is willing to pay toward any fit-out work the tenant wants to do. Usually landlords restrict these funds to items that will be capital improvements and will add benefit to the space should the tenant move out.
How Do I Finance My Tenant Improvements?
There are many ways to finance tenant improvements. If the business has the money, paying cash is a great option. Sometimes, however, the business does not want to spend their money on the fit-out, so they may ask the landlord to finance it for them. If the landlord is open to this request, the expenses are estimated in order to obtain the true fixed amount of the fit-out, and then the landlord decides on a loan rate to charge. The loan term is usually the same as the base lease term; so, if it’s a five-year lease and the tenant is trying to finance $50,000 of fit-out costs at an eight-percent interest rate, their monthly payment would be $1,014.
Sometimes landlords will handle the fit-out payment as a separate loan payment so the business can pay it down sooner. Other times, they may agree to “bake it into the rent”; so if the base rent is $8/sf, it may be $15/sf with the tenant improvements “baked in.” Some landlords are not interested in financing all of the fit-out and may require the tenant to pay a deposit or down payment on it. Again, there are many hybrid options here, as well as programs that help small businesses with their fit-out expenses.
Note: I always caution people on their tenant fit-out. You want to master-plan your space, but if you do not need everything on Day 1, then step into your expenses. Do what you need to do now; otherwise it may cost more such as roughing in a sink for a future kitchenette area.
How quickly can I get into the space? Or, what is the lease commencement date vs. rent commencement date?
Lease commencement date is the date the lease is legally in effect. A lot of landlords use this date to determine when the tenant can get into the space to start their fit-out work. Rent commencement date is the date the tenant has to start paying rent.
What is a Letter of Intent vs. a Lease?
A Letter of Intent (LOI) outlines the terms and conditions of the lease in a simple format, and serves as the base data for creating the lease. However, it is non-binding, so don’t sign the LOI thinking you have confirmed the space. The space is not confirmed until you have a fully executed lease.
A lease is a legally binding document which outlines in detail all the conditions and terms of the relationship between the tenant and landlord. The lease is not fully executed until there is an exchange of consideration, which is usually in the form of a security deposit. Once the lease is signed and fully executed—which usually means the security deposit and first month’s rent have been paid, though this varies by landlord—the landlord will usually let the tenant move in if they have their renters insurance and utilities are in the tenant’s name.
There are many more details that go into a commercial lease and finding the right space—that’s why you want to have a good business team surrounding you. Your team should include, at a minimum, a real estate attorney, CPA and a commercial real estate agent. These experts will look out for your best interests and make sure that you set up your lease and any fit-out costs so they are beneficial to you and your business. iBi