In commercial real estate, the lease is everything. The lease is the contract that guarantees the income to the property; it is the document that, for all intents and purposes, gives a property its value. In other words: you can take it to the bank.
From the basic rules of doing business to the language of expense recoveries, the lease is both the guide for a mutually beneficial relationship and the rule book on how the parties conduct their business.
Leases and legal language can be quite intimidating. Whether it is a three-page form from the local stationery store, or a fully negotiated and vetted contract drawn up by opposing counsel, it’s imperative that property teams are familiar with the language and all the important points in the documents.
This guide will explain everything you need to know to make sure you’re managing leases effectively and maximizing your Net Operating Income (NOI). Let’s get started!
NOTE: This article explains lease administration for the U.S.
What we’ll cover:
> What is lease administration and why is it important?
> Lease basics
> Main types of commercial leases
> Common lease clauses you should know
> Key lease administration tasks to complete
> Can lease administration software help?
> The lease is about more than start and end dates
What is lease administration and why is it important?
Lease administration is the process of making sure the terms of the lease are followed. This can include anything from the payment of rent and common area maintenance charges to repairing obligations and serving of notices. Lease administration is one of the key components of proper property management. Knowing the important terms, timing, clauses, and stipulations, means that a property manager understands the commitments between the parties.
Lease basics
To truly understand a lease, one must look at the bundle of rights theory. An owner of a bundle of rights (a “lessor”) may convey to a tenant (a “lessee”) a right to use and occupy a property for a fixed period of time. In return, the tenant agrees to pay some form of consideration.
The owner of real property has the right of freedom of contract, which allows for a myriad of lease arrangements. That’s why lease administration is the most important part of managing a property.
In addition to the general contractual obligations between the two parties, the lease is the relationship guideline as well. The terms and conditions are structured for the parties, including but not limited to the term, the rents and other financial obligations, the property or portion of the property being leased, and the rights and responsibilities of both parties.
Main types of commercial leases
Full-Service Gross
A lease where the lessor is responsible for paying all property expenses, such as common area maintenance (CAM), taxes, and insurance.
Modified Gross
A lease where the tenant pays base rent at the start of the lease but takes on a proportional share of some of the other costs of the property, such as utilities, maintenance, property taxes, insurance, etc.
Net Lease (also known as a triple net lease or NNN lease)
This lease requires the tenant to pay a portion (usually prorated based on a formula) of the operating expenses (CAM), property taxes, and property insurance spent on the property.
Read more: The main types of commercial leases - pros and cons
Read more: Triple Net Leases: What Landlords Need To Know
Common lease clauses you need to know
A lease is a legal document and it can be overwhelming to read through all of the legalese. But these terms and clauses are essential to both understand and properly interpret. Different leases will have different clauses but this is a selection of common ones to be aware of:
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Rental amount and payment terms
What amount is due to the lessor from the lessee and how often will it be paid. Not all leases are monthly. In some instances, they could be annually or quarterly. In certain areas, specifically when there is a season (e.g. beach town or ski resort), the tenant may only be required to pay rent when open.
The lessee may have an increased amount from the initial lease term. That increase could be negotiated to be a set amount on a regular basis (annually) or it may be increased by inflation (CPI). In some instances, the lessor may want an amount that is indexed to inflation but there is a minimum amount (e.g. “CPI or 3%, whichever is greater”).
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Payment method and allocation
The lessor may require that the lessee pay by ACH or by check. In some instances, if the lessee has had checks returned for lack of funds, the lessor may insist that payment is by cashier’s check or money order. The lease may also state specifically how the payment amount is allocated against the tenant charges (e.g. delinquent rent, then late fees, then current rent, then CAM and expense recoveries).
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Lease duration including start and end date
Dates are an important part of a lease. The lease duration may be stated in months or years. Important dates include the date the lease was executed, when the rent commences, when the tenant occupies the space and when the lease expires.
The lessor may require the lessee to secure the premises with an amount that will be held by the lessor for a designated period. The security deposit may be in the form of cash (check), bond or letter of credit.
All parties to the lease need to be named. The lessor as landlord, the lessee is the tenant. Other names that may be on the lease include the tenant’s trade name (“DBA”) and the property manager or other agent of the lessor. If the lessee is a corporate entity the name of the authorized corporate agent and a guarantor may also be named.
This is the physical address and should be described by a unit or suite number as well as the approximate square footage being rented.
If the rent and/or additional rent payments are received by the lessor after they are due, the lessor reserves the right to charge a penalty. This amount may be based on a percentage of all or part of the amounts that are delinquent. It can also be a fixed amount or a combination of a percentage and fixed amounts.
The lessor may be very particular about the type of tenants who operate on the property and will specifically state in the lease what the type of business is operating in the space. This is particularly important in retail, as tenant mix can impact the surrounding businesses. Additionally, certain types of business may run afoul of local zoning ordinances and impact the space and the property.
An important clause in both retail and office assets as it impacts other tenants and operations. In buildings where there is a central plant running mechanical systems and there is a security detail, a lessee operating outside normal business hours may impact operations. As an example, an accounting firm that plans on working on weekends during tax season will expect that the air handling system will be working during those days. In retail, it is important that all tenants are open at the same time to maximize sales opportunities for all tenants.
An amount beyond the minimum rental amount. It may include expense recoveries for CAM such as utilities, and special fees and charges that have been mutually agreed upon by the parties.
An assignment is the ability to transfer the rights and obligations of a leasehold interest to another party. A sublease is when a current lessee maintains their obligation in the lease but effectively becomes a lessor and leases their space to another party. In certain instances, a lessee may need to close or move their business but is legally bound to the agreement. Having the ability to sell the business and assign the lease is an important clause for the transfer of ownership. When a company needs to close an office or a store, and they cannot terminate their lease, they may wish to rent their space to another party in order to mitigate their losses.
Abandonment is the voluntary surrender of the property without a successor. The property will then revert back to the lessor. Reversion does not relieve the contractual obligation of the lessee. Default is when the lessee fails to fulfill their obligations under the agreement. This concept is important because it gives the lessor the ability to gain access to the premises. For retail properties, this is particularly important because occupied units have a direct impact on traffic and a unit that appears vacant can have a negative effect on other tenants.
Lessors require insurance for protection of both the lessor and lessee. Common insurance includes liability and property protection. Other types include business interruption and loss of use. The lease will specify both a minimum amount of the insurance and that the lessor be named as an additional insured.
This is an assumption of risk whereby the lessee will agree to reimburse the lessor, or pay directly for any claims, suits, liability or expenses related to a liability that may occur on the property.
An agreement negotiated between lessor and lessee that is included in the lease for some benefit for the lessee at a future time. Options can be to purchase the property, to take additional space, to terminate the lease early, to move from unit to another or to extend the lease at the end of the current lease period for a predetermined amount.
Changes or extensions to the current lease. Because a lease is a legally binding contract, the only way to make a change to the agreement is to create an addendum.
Related: 8 key considerations for landlords when entering a lease agreement
Key lease administration tasks to complete
Once you’re well acquainted with the various nuances of commercial leases, the real work starts as you begin managing everything set out in there. Your key tasks will include:
- Abstracting a lease - This is the process of understanding the most important and frequently used information within a commercial lease. It is a review and description of all the important legal, financial, physical and business details.
- Managing critical dates - Missing a critical date can have serious financial and legal consequences. This task involves staying on top of key dates related to the lease such as insurance expiration, exercising of options, rent increases, and lease commencement and expiration.
- Understanding lessor/lessee responsibilities - The lease should clearly define the responsibilities of all parties to the agreement, including physical attributes (e.g. roof, HVAC, parking lot, etc.), operations (e.g. security, lighting, trash removal, etc.) and financial (e.g. audit, payment delivery, insurance payouts, etc.).
- Tracking certificates of insurance - Tracking insurance includes confirmation that the lessee has the proper insurance coverage including the type and amount of insurance as specified in the lease. It also means that the lessor has been named as an additional insured and that the insurance company is reputable.
- Explaining and managing expense recoveries - Understanding the minutia of these very important clauses is critical to maximizing the net operating income (NOI) of the property and providing the best customer service. Tenant relationships can be frayed when a lessee doesn’t fully understand the operating expenses for which they are being billed. By having a thorough comprehension of each individual component, the lessee’s pro rata share percentage calculation of all property expenses and the amounts, will help in explaining and justifying the amounts
Related: What to know when leasing out commercial property
Can lease administration software help?
As you can see, there are numerous activities involved in proper lease management and this creates a significant amount of moving parts to coordinate and stay on top of. This is where technology becomes increasingly important. Automated, intelligent property management software, such as Re-Leased, can simplify how you monitor and renew leases and manage other critical dates from a single dashboard.
Whether it’s leases and their important terms and conditions (such as start and end dates, rent increases, insurance information, expense recoveries), property information or maintenance requests, today's technology can give users a 360-degree view of their portfolio.
By driving workforce efficiency, technology can help commercial real estate organizations save time and eliminate data redundancy, input errors and costly missed critical dates. This is also a significant time saver as it takes away the need to find and surface key dates and it helps eliminate the risks of missing those dates.
Information in a cloud-based system is updated in real-time and is the same for anyone who accesses it, providing you with a single source of truth to work from that is accessible from anywhere with an internet connection.
Automation is another big advantage with a cloud-based property management system which frees up your time and removes the risk of human error.
Here are common workflows which can be automated using Re-Leased:
- Generate and send rent, additional rent and on-demand invoices
- Send notifications to tenants & owners
- Track payments and delinquencies
- Push reminders to your email or phone
- Generate statements and send to owners and creditors
See how 100 Market Group uses Re-Leased to streamline its business
The lease is about more than start and end dates
Understanding and then managing every key lease detail is no small feat but it’s also critical to effectively managing commercial properties and increasing NOI and property value. While the blueprint for proper lease administration has largely remained the same over the years, the advent of tools and software to support and automate these processes has helped streamline how managers work and serve their tenants. After all, your tenants are your customers and setting the foundation for a great relationship through how you manage the lease is worth doing right.
Learn more about how Re-Leased helps you handle the intricacies of lease administration with ease HERE.
