Commercial Real Estate Basics for Small Business Owners
Just starting out with a brick-and-mortar small business? Here is everything small business owners need to know about commercial real estate.
When you’re starting out with a retail, restaurant, or other brick-and-mortar small business, the time may come when you need to rent a commercial space in which to operate your business. Victoria Felix of Keller Williams NYC Tribeca conducted a webinar that explains commercial real estate basics for small business owners. This article contains almost everything you need to know in order to feel comfortable renting a commercial space for your business so you can get started with the commercial leasing process.
General Real Estate Terms
We will start with definitions of some common real estate terms so that when you speak with a commercial real estate broker, you can follow the conversation and know exactly what they’re talking about. If you’ve ever rented an apartment, these terms will probably already be familiar to you.
A lessor, or landlord, is the person granting the lease and who has legal obligations related to the lease contract. The landlord can be the property owner, property management company, or commercial leasing company.
The lessee or tenant is the person leasing the property or space. Although you may need to personally guarantee the lease, your business entity should be the official lessee on all documents relating to the lease.
A sublease is a lease between a tenant who already holds a lease and the sublessee who wants to use all or part of the tenant’s space. The tenant assigns certain rights they hold to the leased property to the sublessee.
The sublessee pays rent directly to the rightful tenant, or sublessor, to either share the space with the sublessor or take over the entire space or property.
The sublessor cannot legally assign rights to the sublessee that the sublessor does not have rights to in their own lease. Additionally, a sublessor cannot sublease unless they are permitted to do so in their own lease.
Terms Specific to Commercial Real Estate
There are some definitions you should know before contacting a commercial real estate broker that is not common knowledge.
Gross Square Footage
Gross square footage is the total square footage of the space being leased. This usually excludes common areas like a lobby or interior courtyard.
Rentable Square Feet
Rentable square feet is a combination of “usable square feet” and some portion of the square feet encompassing the common areas. Typically, there is a 10% to 15% difference between usable square feet and rentable square feet. In New York, that difference can be as much as 30%, so keep in mind that number may differ by geographic area. Rentable square feet usually reflects a higher cost than usable square feet alone. It usually is calculated by adding the usable square feet and some percentage of the common area within the building.
Usable Square Feet
Usable square feet means the square footage that is rented to be used exclusively by the tenant. It includes private (tenant-only) restrooms, closets, storage, and any other areas used only by the tenant.
The term “base rent” refers to the minimum amount due under the terms of the rent.
Addition rent refers to items that a tenant may be charged for that are not included in the usable square footage or other rent costs. These costs can include:
- After-hours services
- Common area maintenance (CAM) fees
- Percentage rent
- Utilities and water
- Any other costs not included in base rent
An escalation clause says how much your landlord can increase your rent each year. In New York City, the traditional increase is 3% of the base rent.
Many office and retail buildings start out with tenant spaces consisting of little more than four walls and a door. The idea is that the space will be finished to meet the specific needs of the tenant. The process of finishing this raw space is known as the “build-out.” There can be extensive negotiations between the landlord and the tenant over:
- What improvements will be made?
- Who will pay for the improvements?
- Who will be in charge of getting the work done?
- What will the tenant be permitted or required to remove at the end of the lease?
A lease assignment clause is a short document that allows for the transfer of the interest in a commercial lease from one tenant to another. In other words, a lease amendment agreement is used when the original tenant wants to get out of a lease and has someone lined up to take their place.
The tenant has the right to install and maintain an exterior sign on the building premises bearing the tenant’s name (the Exterior Signage.) The design, size, specifications, graphics, materials, the manner of affixing, exact location, colors, and lighting shall be consistent with the quality and appearance of the premises and is subject to the approval of all applicable governmental authorities, as well as the landlord’s approval.
Outdoor or Sidewalk Seating
A business must have a Sidewalk Café License and revocable consent if it operates a portion of a restaurant on a public sidewalk. This license is usually governed by the Department of City Planning.
There are three types of sidewalk cafés:
Enclosed Sidewalk Café
An enclosed area on the public sidewalk in front of the restaurant is constructed predominantly of light materials, such as glass, plastic, or lightweight metal.
Unenclosed Sidewalk Café
An outdoor area on the public sidewalk in front of a restaurant that contains removable tables and chairs.
Small Unenclosed Sidewalk Café
An unenclosed sidewalk café contains no more than a single row of tables and chairs next to the building. The tables and chairs can occupy no more than four feet, six inches of the public sidewalk.
How to Determine the Square Footage Needs of Your Business
To figure out how much space your business needs to successfully operate, you should first make a list of activities and areas required by the business, such as retail floor space, a gift-wrapping area, kitchen area, storage (dry and cold) for example. It’s important to consult with an architect to make sure you take all space requirements into consideration before designing plans and beginning the build-out.
How to Choose a Commercial Real Estate Location
Research your desired market and clientele and find out where they live, eat, and shop. Make sure the area has a dollar per square footage that meets your budget. If you choose a building or neighborhood, make sure to know the businesses that are located in that area. Research who would be on either side of your storefront, who is across the street, and find out where your competitors are located. The traffic they bring to their business may visit your business as well. That said, if there is too much competition in close proximity, you might not want to or be able to get a lease there.
If your business requires equipment, such as kitchen equipment for a restaurant, consider the expense of starting fresh versus renting a space that’s already outfitted with some of the equipment you may need.
Consider parking and how much of a shared parking lot your business might need to use. Parking is a negotiated part of a commercial lease.
Commercial Lease Terms
In New York City, a retail lease of one to three years is acceptable. Leases are expensive there, and people aren’t often tied to a long-term lease. If you’re scouting a retail location where there is often significant turnover in businesses, the landlord might not want to grant you a five- to ten-year lease. If you are confident in your business concept, you might push for a five-year lease because you will probably be able to negotiate a lower rent depending on the area you’re servicing and the type of business you have.
A short-term or pop-up lease is for a seasonal business or other purposes for requiring a retail space short-term.
Types of Commercial Real Estate Leases
There are many different types of commercial real estate leases, but we will only discuss a few of the most popular here.
Gross Lease / Full Service
The tenant pays a flat rent amount, and the landlord pays for all property charges regularly incurred by the ownership of the property, including taxes, utilities, and water.
Triple Net Lease (NNN)
The type of lease includes property taxes, property insurance, and maintenance of the common area paid based on the square footage of the property you occupy.
Modified Gross Lease
A modified gross lease is a type of real estate rental agreement where the tenant pays base rent at the lease’s inception, but in subsequent years pays the base plus a proportional share of some of the other costs associated with the property, such as property taxes, utilities, insurance, and maintenance.
A modified gross lease is more popular with tenants because its flexibility translates into an easier agreement between the tenant and landlord. Unlike the NNN lease, if insurance, taxes, or CAM charges increase, the lease rate would not change. If those expenses decrease, the cost savings are passed on to the landlord. As janitorial service and electricity are not covered, tenants can better control how much they spend compared to a gross lease.
Before deciding on a location and signing a lease, compare similar nearby locations and compare the rent. Work with your broker to secure the information.
Evaluate the condition of the building as well as the space you intend to rent. Make sure the interior and exterior of the business—including systems like electrical, and plumbing—and the soundness of the building and the roof are in good condition and won’t hamper your business operations in any way.
How Long Does it Take to Negotiate a Commercial Real Estate Lease?
It’s important when starting out with a brick-and-mortar business to give yourself plenty of time to negotiate your lease before you plan to move it and open for business. For a new business, plan to give yourself up to six months to negotiate the lease.
For a renewal, start to think about whether you want to stay at that location up to nine months in advance of the renewal date so that you can start negotiating with your existing landlord. That way if the negotiation falls apart, you will still have time to relocate your business with minimal disruption to your operation.
Do You Need a Real Estate Attorney?
It’s highly advisable you have your lease agreement reviewed by a real estate attorney. Any oversight on your lease can ultimately cost you money in the end, over and above attorney’s fees. A real estate attorney may also help you negotiate more favorable terms, which could save you money or trouble in the long run.
An attorney can help you negotiate your personal guarantee. Before a bank lends money to a startup business, they often require that the business provides additional guarantees in case the loan can’t be paid off from the assets or cash flow of the business. A personal guarantee requires the individual to pay back a loan personally in the event of default. In the past, this requirement for a personal guarantee on a lease was not common, but since the recession of 2008, it’s become much more common.
The tenant improvement allowance is the amount a landlord is willing to spend so that the tenant can retrofit or renovate the office space. It’s usually expressed in a per-square-foot or total dollar sum. This amount is decided upon during lease negotiations.
Commercial Real Estate Broker’s Role
Consider your broker your advisor during the process of negotiating your lease. Commercial leasing brokers can help you rent retail stores, office spaces, industrial facilities, commercial condos, and other commercial real estate properties.
You want to make sure you are using a separate broker from your landlord because you don’t want to rely on someone as your advisor who has the other party’s best interests at heart when you’re trying to negotiate. Your broker will facilitate negotiations regarding all aspects of the lease terms. Their goal is to bring the parties, including the attorneys, to the agreement on all terms, leading to the closing of the deal.
Make sure your broker understands your product offering and target market. This will then determine your location, price point, and the basic physical requirements of your business. The tenant’s product and brand will determine the type of location, for example, a strip mall vs. a local commercial strip, and an urban commercial location vs. a suburban mall. This all depends on budgeting.
If you’re excited to open a brick-and-mortar business, it’s important to find a commercial real estate broker who you are confident can help you through the process.