As a business owner, you may find yourself in need of new facilities, either to begin your business operations or to expand an existing company. No matter what sort of business you may own, the kind of property you will ultimately select will most likely constitute commercial property. A commercial building is simply real estate property that is utilized for a business purpose. Commercial property can further be divided into six subclassifications according to the specific business activity conducted on it. Renting commercial property for your business is not usually quite as simple and straightforward as securing a residential lease for an apartment, for example. Negotiations for commercial buildings and property can be quite a bit more complex, as can the lease terms, with a number of different lease structures that may be offered by various commercial landlords.
TL;DR (Too Long; Didn't Read)
A commercial building is one that is utilized for a business purpose, either directly by housing a specific business or by generating a profit, as with residential rental buildings.
What Is a Commercial Building?
Any piece of real estate that is used for business operations and activities constitutes commercial property, whether it is simply bare land or it is improved with buildings and other facilities. A commercial building is any structure in which a business purpose is pursued or operated. That includes both direct uses, where the company conducts business out of the building itself, and indirect uses, where the building itself is the business.
An example of a direct use of a commercial building would include a grocery store or mechanic’s shop located in the building in question. An example of an indirect business use is apartment buildings, where the lease of individual apartments is the business activity that takes place in those buildings.
Buildings and property that are designated as commercial in nature are subject to different tax and financial rules, as well as additional or different legal requirements and prohibitions, in many cases. Commercial designations also trigger different financing rules for purchase, lease and improvement.
Examples of Commercial Buildings
Commercial buildings and property are generally classified into six different types or categories:
- Office buildings
- Retail buildings
- Industrial buildings
- Multifamily housing
- Hotels and motels
- Special-purpose buildings
Whether located in cities or suburban neighborhoods, office buildings are a commonly seen type of commercial building. From smaller buildings of a few floors to skyscrapers hundreds of feet high, office buildings can be found just about everywhere in the United States and other developed countries. One specific subtype of office buildings, the medical office building, is considered a specialized use. Office buildings of all types may lease individual offices, suites or floors to many tenants or to a single tenant, who then subdivides the building as they see fit. In many cases, office buildings are offered to tenants along with the opportunity to have the space built to the tenant’s specifications.
Retail properties and buildings house all kinds of retail sales shops and restaurants. This segment of the commercial property market can be quite complex, with numerous local zoning regulations and state laws applying to various types of retail buildings and with market-rate rents depending heavily on the type of building, the size, the layout and the number and type of tenants. For example, retail properties may be single-occupancy buildings, such as outparcels housing a single drugstore, or large, multi-tenant properties, such as malls anchored by a few large stores with multiple smaller shops, booths and kiosks in between.
Buildings in which manufacturing, repair, research and development and warehouses are located are known collectively as industrial buildings. These commercial buildings tend to be located in specially designated zones created by local ordinances and regulations. They are generally located outside of heavily urbanized areas but are near interstate highways and other significantly traveled roadways, railways and transportation depots. Often, the designated industrially zoned areas will be organized into industrial parks that house facilities for several companies. Because of the additional noise and traffic industrial buildings tend to produce, these zoned areas are usually isolated by buffer areas from residential neighborhoods.
The multifamily commercial building is restricted essentially to all residential real estate that can house multiple families onsite. This would exclude single-family homes but would include condominium, apartment and townhome developments. A multifamily residence is engaged in a commercial purpose through the investment and management of its owners, with the income flowing through the residents’ payment of rent. Apartment rental buildings are further classified along the following lines, based on floors, location and the presence or absence of an elevator:
- High-rise buildings include one or more elevators and at least nine floors.
- Mid-rise buildings include multiple stories, though typically less than nine, and an elevator.
- Walk-up buildings have multiple floors, usually four to six, but no elevators.
- Garden-style buildings house multiple apartments in three or fewer stories with a courtyard or garden-like landscaping.
- Manufactured housing parks or communities (also known colloquially as “trailer parks,” though this is often meant in a derogatory sense) offer land lots for rental to owners who place their mobile or manufactured homes (single- or double-wide homes) on the lots and connect them to existing utility sources.
- Special-purpose housing is any kind of multifamily residential property that is dedicated to or specifically aimed at a particular segment of the population, such as low-income families or senior citizens.
Hotel and motel properties provide on-demand accommodations for business and pleasure travelers. Hotels can be large-scale and either independent boutique hotels or chain-owned. Hotels with higher price points tend to provide or rent space to other supporting businesses that provide added value for hotel guests, such as spas, hair salons, restaurants, bars and clothing retailers. On the other end of the spectrum are low-end motels with no additional amenities or onsite restaurants. In addition, large resort areas and casinos are specialized hotel properties that offer accommodations at a wide range of price points.
Finally, there is a catchall “special purpose” category that includes nonresidential properties that are held by owners who invest in commercial real estate, but the properties don't naturally meet any of the above characterizations, such as bowling alleys, miniature golf courses and storage facilities.
What Is the Meaning of a Commercial Lease?
In addition to the several categories of commercial property, you may also encounter different kinds of commercial leases. While commercial lease agreements tend to contain several types of common boilerplate clauses, the specific structure of the lease’s terms can differ quite dramatically, including most particularly the tenant’s payment obligations. Which type of lease is right for your business depends on many factors, including your business plans and goals for the property, your cash flow projections and cash on hand and other elements of your company’s finances and operations.
A single-net lease or net lease obligates the tenant to pay only regular rent (however that may be calculated), utilities and property tax. The landlord in a net or single-net lease takes care of (or pays for) maintenance, repairs and insurance on the property and all improvements thereto.
Double net and net-net leases generally require the tenant to pay rent, utilities, property taxes and insurance for the building and any part of the premises occupied by the tenant. The landlord only pays for maintenance and repairs or performs these at his own expense. In triple-net leases, the landlord pays for structural repairs to the property or buildings only, while the tenant assumes all other expenses and costs in addition to the rent.
Finally, the full-service and modified gross lease generally divide the costs for structural repairs and all the costs that fall under the label of “operating expenses” (including property taxes, insurance premiums, utilities and maintenance) between both parties. For buildings that house multiple tenants, such as malls and shopping plazas, the full-service or modified gross lease structure is the most commonly adopted type. If operating expenses increase, the rent does not.
Negotiating a Commercial Lease
When searching for the right commercial property for your business, the suitability of the property and its buildings for your business purpose are just the beginning. You will also need to reach an agreement with the landlord on commercial lease terms that are suitable for your business needs, goals and finances. Negotiating your commercial lease terms can be a stressful or even anxiety-inducing experience if you’ve never done it before.
As a preliminary negotiation tool, it’s always smart to research rents for comparable locations and facilities. Find out what rental and lease terms are offered for those locations, as well as any significant differences among the properties so that you can address any objections from the landlord. When you’ve done your homework and understand the average rental rates in the area, you’re more empowered to reach terms that are mutually beneficial and fair. By the same token, if you find numerous locations that are similarly suitable for comparison, you may be in a renter’s market, and you may be able to convert that into a negotiating advantage. At a minimum, you should consider asking for a shorter lease term duration (one year, for instance, instead of two), in the event that rents begin to fall. That will free up your business sooner to find a better set of terms. This may not be the best approach, however, if your business requires a fixed-location commitment, such as a fine-dining restaurant.
Speaking of the lease term, pay special attention to this part of the lease agreement. If you’re satisfied with the location and your company’s lease application was approved by the landlord, the next biggest question is the term of the lease itself. Some businesses, such as restaurants, will require a longer lease term, but for most small businesses, a term of one or two years with optional renewal periods is most commonplace and generally best suited for the tenant. You’ll enjoy some certainty and enough time to establish your operations and attract the right flow of clients or customers to that location, but your business won’t be tied to a lengthy term.
Finally, pay attention to much more than just the amount of rent. Other costs, depending on the specific type of lease structure you’re being offered, can add substantial expense to your building expenditures and put a real strain on your budget. If your business will be responsible for costs and expenses in addition to the rent, it’s important to get an estimate of those costs in order to create an accurate budget and estimate for your business finances. These so-called hidden costs may include maintenance or common area upkeep and can be quite substantial. To secure the most favorable terms possible, consider asking for a cap or maximum amount you can possibly be assessed for these items or alternatively consider exchanging the structure for one in which the landlord assumes those costs and your business pays a higher rent. This will add certainty to your budget and make financial projections much easier and more accurate.