A commercial real estate also known as commercial assets can be defined as a property that is solely used for business purposes.
A landlord may rent the property as a workspace or as a living space to the company for their employees.
Commercial Zoning can be described as areas or parts of the city that have been set aside for those properties that are built for business purposes only. When city planners divide a city, they choose which areas will be used as residential, mixed residential-commercial, commercial, and industrial zones.
Zoning laws are used to determine how such land or property will be used. Usually, these land use laws fall under municipal jurisdiction. That means each zone has its own specific limitations which may include the types of spaces that can be built there, the size of those spaces, the use of those spaces and the density of the development. Regulations surrounding commercial zones include those on noise emissions, parking, and waste management.
A landowner or real estate developer requires such information concerning commercial zoning if they aim to rent a commercial building.
For a landlord, they need to be aware of the zoning restrictions in the places where their properties are when reviewing the commercial lease applications. This will be beneficial in determining the types of tenants a landlord rent out their property to.
Types of Commercial Property
Commercial property differs in type, which is usually dependent on the different business requirements. It is necessary that landlords and tenants understand the difference so as to smoothen the leasing process. To provide insight into this, below are the common types of commercial property.
Commercial property suitable for offices is characterized by having a number of rooms/offices that can be rented out independently or to a single tenant. Office commercial properties can be located at the heart of downtown or on the outskirts of towns and suburbs. Depending on the quality of the space and suitability in terms of location, office commercial properties are classified as Class A, Class B, or Class C. They are suitable for different types of trades and professions such as legal offices, accounting firms, consultancy offices, etc.
Retail / Restaurant
Retail and restaurant properties are conveniently located in shopping malls, shopping centres, or strip malls. They are more suitable for fast food restaurants, clothing stores, accessories shops, chain stores, and brick-and-mortar shops for online retail businesses. Leasing large commercial property such as shopping malls can be complicated, especially when dealing with exclusive rights as multiple tenants with all sorts of business types are expected to rent the space.
Industrial, commercial properties include warehouses, manufacturing buildings, storage spaces, and spaces rented by businesses for industrial use, such as office space for employees. Industrial spaces are normally rented by businesses that specialize in manufacturing, after which they send products to retail shops or other manufacturing companies. Industrial lease properties are usually located outside the city. Its suitability will be dependent on the property’s closeness to transportation routes and its compliance with the manufacturing standards. Common types of industrial spaces include those suitable for heavy manufacturing, flex and bulk warehouse, light assembly, and Research and Development facilities.
There are other non-residential properties which are rent out for other uses, such as personal storage facilities, hotels, and medical clinics.
Difference between Commercial vs. Residential Lease
Here is the difference between the two:
- A landlord should be aware that residential leases present an easier evaluation of residential properties in terms of value as compared to commercial properties whose value requires an evaluation from a professional.
- A commercial lease is a contract binding a tenant and a landlord regarding a property meant for business activities while a residential lease binds a tenant and a landlord regarding a property intended for residential purposes.
- While a residential lease can last for a monthly-basis or for one year, a commercial lease my last for up to five years.
- A landlord gets more income of up to 50% on commercial lease properties as compared to residential lease properties where there is lack of constant cash flow
- There are more legislation obligations surrounding commercial leases as compared to residential leases.
- Unlike a residential lease which has a particular standard when it comes to renting out a property, commercial leases do not have a singular standard. Most commercial leases are unique to the tenant and are based on the agreement between a landlord and a tenant.
Steps to Rent the Commercial Property
As a landlord, it is important to familiarize yourself with the process of renting a commercial property to ensure the correct procedure is followed. Commercial lease suitability is dependent on location, the condition of the property, market conditions, and others. Each property is unique and should; therefore, its lease agreement terms should be negotiated with that in mind. The process of renting commercial property should be carried out as discussed below:
Hire a real estate agent
A real estate agent/realtor can be consulted. As they are deemed more informed about the lease markets, they can assist in setting rental rates that mutually benefit the landlord and the tenant. This could be in relation to rental rates of other similar commercial properties in the locality.
Hiring a realtor will come at a price; ordinarily, it is set between 4-6% of the total rent amount. For example, for a 10-year lease of $10000 annual rent and the agent asks a 5% fee, the agent’s fee will be $5000. 50% of the fee is paid once the lease has been initiated, and the other 50% once the tenant takes occupancy.
If one chooses not to use a realtor, they should verify market conditions before setting their preferred rental rate. This can be through comparing the prices of different commercial listings on available online platforms.
List the property
A Realtor’s job description involves listing the property for sale, so if a landlord opts to involve a realtor, the listing should not be a source of worry to them. However, if a landlord chose to market the property themselves, they would have to assume the responsibility of listing the property, usually done online these days.
When listing the property, one should ensure that they use clear and nice-looking pictures of the interior and exterior accompanied by images of the common areas. One should include the available amenities, water, parking, sewer services, and any other details that would be important to a prospective tenant in the listing. Popular commercial listing sites in the US are viable options to use.
Pull property data
Property data is important when determining the feasibility of a business if it is set up at a particular property. Property data is especially crucial for retail tenants who are highly dependent on traffic and demographics. Traffic data necessary for evaluating property suitability can be obtained from the Department of Motor Vehicles in one’s state for free. Demographics data can be obtained from the US Census Bureau. Other property data include income levels within the locality. Property data is known to influence rental rates; higher traffic rates will command higher rental rates.
Prepayment of rent
Sometimes tenants may prefer to pay a certain amount of rent in advance. Prepayment facilitates negotiation for a lower rental rate; for example, if a tenant can pay 6-18 months’ rent upfront, the landlord may be convinced to reduce the amount of rent. Paying a significant amount of money as a security deposit can also be required by the landlord to sign the agreement.
Set the price per square foot ($/SF)
The rent should be set in terms of price ($) per square foot (FT), which is representative of the annual rent for the commercial space. It is determined by dividing the annual rent by the total square footage unless it is a land lease. For “living space,” square footage is determined by measuring the length and width of the interior walls. To illustrate the relation between rent and square footage, the following examples have been provided.
Determining $/SF from annual rent
If a landlord is leasing a 2500 square feet space for $10000 per year, the $/SF would be given by dividing the $100000 by 2500, which gives a $/F of $40/SF.
Determining $/SF from the monthly rent
In a situation where a landlord is charging $2000 per month for a 1000 square feet space, the $/SF can be determined by multiplying $2000 by 12 months and dividing the product by the total square footage. This would result in $24000/1000, which gives $24/SF.
Determining Monthly rent from $/SF
In a situation where the landlord is offering a 4500 square feet warehouse at $15/SF, the monthly rent can be determined by multiplying $15/SF by 4500, which gives an annual rent of $67500. This is then divided by 12 months to get $5625 as the monthly rent.
Verify market conditions
Verifying market conditions helps with setting rental rates. It is important to verify what other landlords and tenants are charging and paying respectively for similar commercial property. It can be done by reviewing other commercial listings in the market that are being advertised on popular listing sites.
The landlord and tenant should do their own investigations. However, if a real estate agent was hired, they should present comparable leases that have been signed as proof of rental rates applicable to other similar tenants and landlords. By verifying market conditions, both parties can have an estimate of how much a commercial space would go for.
Conduct a credit check (Business + Individual)
Conducting a credit check is important in order to have an idea of a tenant’s financial status. This is even more important because when dealing with entrepreneurs and small businesses as tenants. Credit checks, business or individual, can be done through the use of any available websites or platforms.
For a business credit check, the findings will usually show the credit history of the company detailing information like how fast it pays back its vendors/creditors and its annual sales.
The cost of such a check is between $39.95 and $49.95, depending on the plan selected.
Businesses are given a score of between 0-100, an 80 and above score representing credit-worthy businesses.
- Good credit history – Tenants with good credit history for paying their creditors on time or have businesses with multiple locations are desirable. Good credit history should be a consideration for landlords before approving tenants. BBB+ or better credit ratings give landlords higher value for their property should they decide to sell in their property.
- Bad Credit History– Businesses that do not qualify or have a poor credit score will often require to sign with a personal guarantee provided the tenant has the necessary assets such as property, home, vehicles, and personal finances. Should the tenant default on lease payments, the landlord is authorized to take possession of the outlined assets in order to recoup their losses emanating from the tenant’s default.
For individual Credit checks, the outcomes will often show the business owner’s income and financial liabilities that could be separate from those of the business. It costs the potential tenant $14.95.
Approval or disapproval of the tenant
Once the landlord has evaluated the tenant’s application, they should then decide to approve or disapprove. If a tenant is rejected, they should be issued a Tenant Rejection Letter.
If a landlord wants to approve a tenant’s application even though the tenant’s business is not credible, a Personal Guaranty should be considered. A personal guaranty binds the owner of the business to the lease such that, should they default, the tenant’s personal assets would also be liable and not just the business.
Negotiating the lease
Negotiations are part of the commercial renting process. So as to have a mutually benefiting agreement, the landlord and the tenant should understand each other. for landlords, it is best to understand what a tenant needs so that together with their agent, they can get creative when formulating a deal. For example, charging the tenant a percentage of their earnings can be more prudent than charging a higher monthly rent, for should the tenant make high-profit margins, the landlord benefits as well.
Determine the security deposit
Once a tenant has been approved, the landlord should communicate the amount of money they expect as a security deposit. In commercial renting, there are no limits as to how much a landlord can charge a tenant for a security deposit, unlike in residential renting, where this is governed by state laws. Ordinarily, a security deposit amounting to 2-3 months’ rent is asked to cushion the landlord should the tenant stop paying rent or cover for damages that may occur during their tenancy.
Write the commercial lease agreement
Once all the relevant information about the lease has been gathered and the terms established, it is time to write the lease agreement. One can opt to craft the lease agreement themselves or use an attorney. Once the agreement/contract is completed, it should be signed in the presence of a notary public to validate the signatures. A notarized commercial lease agreement’s legality is least likely to be questioned in a court of law.
Mention lease type
When renting a property, the question of whether the rental rates cover the real estate taxes, insurance, and/or maintenance of the property should be answered when advertising the property. The most common lease types are:
- Gross lease – This type of lease informs the tenant of the landlord’s responsibility to pay for insurance, property taxes, and property maintenance.
- Triple (NNN) lease – This type of lease implies that the tenant will be obligated to pay the monthly rent expected, which is inclusive of property taxes, maintenance, and insurance.
Soon after the tenant pays the security deposit and the check clears, the keys can be handed over, and the tenant can start using the space as agreed on in the rental agreement. Both parties (landlord and tenant) are obligated to abide by the rental agreement and be held accountable until the end of the lease term.
Free Renting Guide
Paying Operating and Utility Costs in a Commercial Lease
As a landlord, it is essential to know who will be responsible for paying the operating and utility costs in a commercial lease. To easily clarify and determine the responsible party, landlords should be aware of the specific sections designed in the commercial lease agreement that provide these directives.
There are three known ways to divide the operating and utility costs in commercial renting. They are as follows:
In this case, the tenant is fully responsible for paying for the operating and utility costs directly to the provider. The tenant does not need to go pay for these services through the landlord.
Some of the services paid for may include:
- Professional cleaning services
- Water and power usage
Payment to landlord
Here, the tenant pays the building costs to their landlord based on their usage on space they have rented. For instance, if a tenant has leased a single space in an entire building, then they pay for their usage to the landlord. If another tenant has leased the entire building, then they pay the proportional share.
Such usage may include:
The services paid for by the tenant will then reach the provider through the landlord. Commercial tenants pay for operating and utility costs based on the yearly estimates from the landlord or monthly in their rent.
Note: For a month-to-month basis payment, the landlord sums up and finds out the total payment for the services.
For this last one, the landlord takes care of all the operating and utility costs. That means that the landlord might either choose to provide these services to the tenant or handle all the payments for the provided services themselves.
Most landlords choose to include the costs of the services a commercial tenant might need into their rent. This way, the landlord can deal with payments on time and avoid any logistics hassle.
Some of the services that fall under this way of payment include:
- Garbage collection and disposal
- Property taxes
Frequently Asked Questions
Yes, a factory is considered commercial property as it generates profit.
A commercial property mainly refers to profit-generating buildings such as a company building, a factory or schools, etc. On the other hand, residential properties are specifically zoned for living. Such buildings include houses, apartments, flats, etc.