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When you sign a commercial lease you will have additional expenditures over and above the amount you pay for rent. The number and type of expenditures will depend on the type of commercial lease you sign and whether or not you sign it in blood. Most commercial leases are triple net leases, as opposed to single or double net leases, which requires a tenant to pay a portion of their landlord's operating expenses. Ultimately, the final lease agreement which spells out what you owe over and above your rent will impact your bottom line, potentially resulting in success or failure for your business. Learning as much as you can about capital costs in commercial leases will ensure you know what you are getting into and can make the best decisions for the future of your business. This guide will go over common capital costs, what tenants might have to pay when they sign a commercial lease, expenditures which tenants are typically excluded from having to pay, and how you can use capital costs as a way to negotiate your lease to get the best terms possible.
To understand capital costs, it is important to consider the ongoing expenses that are required to be paid, and are NOT capital costs:
When you are considering on leasing a commercial property for your business, you will find the type of lease you sign is classified by the extent to which you contribute to the property owner's operating expenses. The most common capital expenditures in addition to your rent fall into the following broad classifications:
These operating expenses are specific to your office or retail space. Some examples include direct utilities such as phone lines, cable or satellite television service, and internet service. Expenditures for unit maintenance can vary greatly based on the type of business you operate. Some examples include maintaining tables and booths if you own a restaurant, fixing broken clothes racks or shelving in a retail establishment, and performing computer maintenance for service oriented businesses like accounting firms or legal offices.
This includes municipal or local taxes on the portion of the land or commercial space which your business occupies. Some states levy property taxes on your commercial assets such as company vehicles, machinery, equipment, and other large assets, but this is a separate expense which would not be included in a commercial lease.
The property owner is legally required to have insurance on the physical space which you rent. Your portion of the the insurance costs might be included in a commercial lease. Keep in mind this insurance does not cover your business assets and protect your from liability for issues which are your responsibility. You will still need a separate business insurance policy to protect you, but this is a separate cost of doing business which isn't included in your lease.
These costs are those associated with maintaining areas on a particular property where benefits are shared among tenants without one specific business owner receiving an independent benefit. Common area maintenance costs can vary based on the type of space you lease and where it is located. Some examples of costs which might fall under this umbrella category include:
Many leases include monthly administrative or management fees which are charged as a percentage of Common Area Maintenance costs and related project expenses. These fees are beyond the actual cost of maintenance and instead, are intended to cover the administrative costs of dividing Common Area Maintenance expenses among tenants.
Unlike operating expenses which are frequent and low-cost, capital costs in a commercial lease are infrequent, expensive upgrades to the property that provide a long term upgrade.
Theses costs refer to the expense of new items for a property or building. Some examples include a new sidewalk, a new parking lot, or a new security system. The extent to which they should or should not be included in a lease depends on the situation.
With normal wear and tear and age component parts of a business property need replacement at some point. Many commercial leases exclude major capital improvements, but include replacement costs when repairing something repeatedly costs more than replacement. This is to be expected because components have reached the end of their useful lives, which results in acquiring new and sometimes more efficient items. Sometimes landlords will argue to convince tenants to pay for things which should be excluded from capital expenditures on improvements. When landlords replace a component, they are replacing something which is already included in your rent. If they pass part of replacement costs onto you, they are charging you twice for the particular item—one time in your rent and another time in operating expenses. You should make sure you aren't paying for replacement items in your lease, and avoid letting your landlord include a replacement item in operating expenses if the situation should arise.
Sometimes repairs and replacements are lumped into the same category, but in many cases they are different from each other. Small repairs and routine preventative maintenance do not increase the value of a property, nor do they make a particular asset last beyond its useful life. In these cases, the landlord should pay for repairs. Yet, when a major, non-routine repair increases property value or adds useful life to an asset, they add to the "betterment" of a property, which means tenants should pay their portion.
Keep in mind that the rent you pay for your commercial lease covers capital expenditures. Your base rent compensates your landlord for your use of the property which includes the structure, its improvements, systems, and equipment. The property owner gets to depreciate his assets each year and the negotiated base rent is assumed to cover use by a tenant. Yet, most commercial leases are drafted by landlords, who include capital expenditures in their operating expenses. They expect you will negotiate better lease terms for yourself. This means you have to spend the time and resources to review lease terms by hiring professionals who are experts in making sure you get what you expect and understand exactly what you will be paying for, so you can reduce potential risks of a lease agreement.
Keep in mind that market conditions will dictate the extent to which you can play hardball when you are negotiating your commercial lease. If vacancy rates are high, it's likely you will have more leverage. Additionally, some landlords are more willing to compromise and negotiate than others. Of course you will negotiate your base rent, which is typically a fixed amount. You can also negotiate the type of lease agreement you want—fixed monthly operating expenses added to the base or a standard triple net lease which allocates expenses.
You will have a little, in some cases a lot, of room to negotiate, but there are some things which should almost NEVER be included in your commercial lease agreement for your business, including, but not limited to:
If you are looking for help in determining how to improve your capital costs in your commercial lease, check out this video on how we may be able to help: