When starting a business, there are many things to consider, especially if you plan to have a brick and mortar location. Where you set up shop matters — and we don’t just mean in a geographical sense. Besides choosing a physical location, you also have to consider if leasing, buying, or building a commercial property is right for you and your business.
Should You Lease, Buy, or Build?
While there are pros and cons of all three, the decision depends on several factors. “The question goes back to your business plan and accountant. Depending on how your accounting is set up, you have to determine if capital expenditures, among other items, are better than operating expenses that come from leasing. If growth and expansion are long term plans, purchasing a property that can accommodate future goals may be the way to go,” explains Dave Johnson, a commercial real estate broker and owner of ORB Real Estate.
If you’re in the startup phase or simply aren’t ready to commit to something more permanent, leasing may be a better option. Some of the advantages include:
Flexibility: Securing a lease is often easier than qualifying for a commercial real estate loan and can provide more options when choosing a location.
Fixed Monthly Cost: With the landlord covering most major repairs and upkeep, the rent generally stays the same, and you’ll know exactly what you’ll pay each month.
Liquidity: While there are initial fees, leasing requires significantly less cash upfront and keeps more funds at your disposal.
Tax Breaks: Unlike a mortgage, you can deduct the entire lease payment. You can also deduct the cost of things like property insurance, utilities, and maintenance.
Benefits aside, there are some key factors to be aware of when renting commercial space, such as calculating rent amounts, types of leases, and best practices to follow.
How to Calculate Rent on a Commercial Property
Commercial rental amounts are determined according to fair market value, which is based on “comparable leases of comparable space.” Rent is then calculated by square footage and presented as either an annual or monthly rate, like the examples below.
Annual Quote: Let’s say a 1,500 square foot commercial space is quoted at $11.50 per square foot. To calculate the annual rent amount, you would take $1,500 x 11.50, which works out to $17,250.
Monthly Quote: To break the total annual rent into monthly payments on that same commercial space, simply divide $17,250 by 12. In this case, the total monthly rent would be $1,437.50.
Types of Commercial Leases
Unlike residential leases, commercial leases tend to have many variables that impact the terms. There are also several different types of commercial leases available. Two of the most common are gross rent and triple net leases.
Gross Rent Lease
A gross rent lease is sometimes referred to as a full-service or all-inclusive lease. In this lease situation, the landlord usually handles expenses like taxes, insurance, and maintenance. The tenant pays a fixed amount of rent, which the landlord uses to pay those expenses. Most gross commercial leases contain escalation clauses that give the landlord power to raise the rent to offset any increases in those expenses.
Triple Net Lease
With a triple net or net-net-net (NNN) lease, the tenant covers most of the costs associated with the property. In addition to rent, the tenant is responsible for property insurance, utility, and maintenance expenses. Triple net leases often include common area maintenance (CAM) fees. These fees are typically a yearly adjustable amount based on the percentage of the building a tenant occupies. For example, a tenant that rents 1,000 square feet of a 10,000 square foot building would only be responsible for 10% of those costs.
Best Practices for Leasing a Commercial Space
If you decide leasing is the right option for your business, Johnson recommends keeping the following in mind.
Always Work With a Commercial Real Estate Agent
Working with a qualified real estate agent is the best way to handle the leasing process. A realtor will make the process easier, including helping you find the right space for your business, needs, and budget. They’ll also help negotiate the lease terms.
There are several reasons someone may hesitate to hire a realtor when looking for a commercial property. However, choosing to tackle the process alone can lead to costly missteps. As Johnson points out, “[Renting commercial space] is not the same as renting an apartment. You need someone to advocate for you when it comes to commercial transactions.”
That said, not just any realtor will do; you need a commercial/industrial realtor. “While we are in the same industry, commercial real estate is a completely different market and utilizes different methods,” Johnson explains. “Commercial purchase agreements and leases are uniquely different transactions and often include tenant improvements, equipment purchase, signage, intellectual property, governmental approval, zoning and infrastructure, engineering, legal services, and special financing.”
Pay Attention to the Details
When it comes to commercial leasing, the details matter. While it’s important to understand the lease provisions, Johnson says its length is especially crucial for business owners.
“Your business success should be your number one goal. Make sure the lease is flexible enough to allow for growth opportunities [whether it’s] expanding within a building or allowing you to move out to a larger location.”
Other details to pay attention to are the condition of the space and terms related to maintenance and upkeep. Before signing any agreements, make sure everything is in good working condition and that you understand who’s responsible for the cost of repairing any issues. “If your lease begins in the winter season, do you know if the AC works? What if it doesn’t, and you sign a lease where you’re responsible for repairing it? At a minimum, get a one-year guarantee free of expenses on HVAC, roof, and electrical systems. All of this accomplished through negotiation,” Johnson notes.
There’s Always Room to Negotiate
One thing that tends to surprise people the most about commercial leases is that everything is negotiable. In many cases, you can even negotiate the broker fees. There are significant advantages to having someone in your corner who is skilled at negotiating the terms of a lease. They’ll not only ensure you find the right property for your business but also save you time and money. From performing due diligence about the property right down to negotiating things like repair costs, a qualified commercial realtor will have your best interests in mind.
Special thanks to Dave Johnson for sharing his insights on commercial leasing! If you’re interested in learning more about leasing or buying commercial properties in Fergus Falls, get in touch with our team. We’d be happy to tell you about the site selection process and available properties in the area.