What Every Business Needs to Know before Signing a Lease Pt. 2 | Brokers Round Table

In part 2, we discuss common lease structures in commercial real estate, emphasizing the importance of understanding tenant covenants and landlord goals. We also highlight the significance of legal expertise in negotiating leases and the potential consequences of not seeking proper counsel. Additionally, we underscore the importance of due diligence when investing in commercial real estate and advocate for education and coaching in the industry.

Key Takeaways:

• Tenants want certainty and predictability in their lease costs, but landlords cannot fully provide this due to unpredictable expenses.

• Triple net leases are the most common structure, especially in retail, as they hold landlords accountable and provide transparency for tenants.

• Lease negotiations require careful attention to key terms like rent escalations, security deposits, operating expenses, and environmental liability.

• Involving both a commercial real estate broker and an attorney is crucial to navigate the complexities of commercial leases and protect the tenant's interests.

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About Your Host:

Tyler Cauble, Founder & President of The Cauble Group, is a commercial real estate developer and investor based in East Nashville. He’s the best selling author of Open for Business: The Insider’s Guide to Leasing Commercial Real Estate and has focused his career on serving commercial real estate investors.

Episode Transcript:

0:00

Are you looking to take the next step toward investing in commercial real estate but don't know where to go? Series central offers a comprehensive education and coaching platform designed to help you get started. Our online courses cover a wide range of topics from the fundamentals to advanced strategies, ensuring you have the knowledge and skills needed to thrive in this competitive industry. As a member, you'll gain access to our exclusive online community and monthly group coaching calls, providing you with valuable networking opportunities and personalized guidance from experienced professionals. Whether you're a beginner or looking to take your career to the next level, cre Central has the resources you need, visit www dot cre central.com. To learn more. Welcome back to the commercial real estate investor podcast for another brokers roundtable today, Chad and I are going to be diving into part two of what every business needs to know before signing a lease. Last time, we ended up spending half an hour talking about just the first section of literally eight sections that we had down to dive into let's talk about today chat, we'll kick it off with lease structures. There's basically three different lease structures that are common in commercial real estate. And of course, you know, industrial has its own lease and you know that you can modify these and kind of anyway, but the the three most common are full service, gross, modified gross, and triple net. What should a tenant want? If they're going to be leasing commercial real estate? Do they want full service where everything's just all included? In one rate, do they want, you know, triple net where, you know, they're gonna have to pay, you know, the commentary, maintenance, property taxes, building insurance, all that kind of stuff. What, what did tenants want?

1:52

I think at the core tenants want, what they can't have. And I don't say that flippantly. But I say it from the standpoint that all tenants want. They want convenience, they want to be clarity, they want consistency, they want everything that a landlord would find impossible to deliver. Because a landlord, especially if it's a longer term lease, if a tenants doing a very short term deal like a month to month or a year to year, it might be possible that a landlord would actually do a full gross lease where they're not passing through any increases in expenses. And they might just say, Here's your rent, it's $10,000 a month, that includes property taxes, insurance and everything. But that if you go beyond a year, a landlord just can't predict what's going to happen to those expenses. Because we don't know what's going to happen with property taxes, we don't know what landscaping costs are going to be. We don't know what all those expenses are. So a landlord can, the best they can do is make an estimate. So even on the full service, gross, it's more common from what I've seen for landlords to still have a base year in there. So it's gross, they might be paying $10,000 a month. But there's probably a provision that that there's a base year where all numbers get adjusted based on that base year. So if there is a increase in property taxes or insurance or any operating level expense for the building, then that does get pushed through to the to the tenant. But I understand why tenants want certainty. They don't want to get hit with a bill at the end of the year saying, We estimated that the cost to operate this building would be x and it turned out to be x plus some amount. So you now you owe us the difference. That's probably the most frustrating thing that I hear from companies, especially new companies that aren't familiar with commercial leases, is they get blindsided by a reconciliation at the end of the year, once a landlord has figured out what their actual expenses were. So that's that's why when I say tenants want something that's that they just can't have. A tenant would rightfully want to have full certainty and know exactly what their bills are. But unless it's a very short term lease, it's it's impossible to deliver.

4:04

Yeah, it makes sense. I mean, most tenants don't think that they actually want a triple net lease, because they're looking at it going well, why am I gonna pay base rent and then pay all these additional expenses, but you're actually paying those in a full service gross lease, I actually think that tenants benefit more from the triple net lease structure than they do from a full service lease structure for a couple of reasons. I mean, one, it's holding the landlord accountable. Right, so you know exactly what is going on. With regards to the common area maintenance, property taxes and building insurance and a full service gross lease, landlords can get tempted, bad landlords and there's a lot of them out there to cut expenses in order to keep more of the profit that's coming in. They don't have any obligations necessarily to keep the building up and running outside of what's already in the lease and they can kind of skirt around a lot of that. Whereas in a triple net lease if the landlord starts cutting their you know, expenses on culinary maintenance, well as the tenant I'm going to get a reimbursement at the end of the year because I I've overpaid for my cam now, and I get to audit you as the landlord. Adam, let's, let's dive into what your thoughts are on the full service versus modified gross versus triple net lease structures.

5:13

It's really rare in my world to do anything other than triple net. So I'm an honestly like, it happens. Very rarely, that, let's say a large landlord has a huge asset, and it's picking number 300,000 square feet. And the retail is only 1000 square feet of it or something like that. Sometimes they will just kind of pick an arbitrary market cam number, and build in yearly increases, just to frankly not have to figure it out and track it, because it's kind of the tail wagging the dog. But, and even that is usually set up as a triple net lease. So the big things in my world, again, you guys know, I kind of wear both hats, right? Sometimes I represent the landlords and sometimes I represent the tenant, the things that I usually find to be just kind of a middle of the fairway, everybody get along kind of scenario is capping a non controllable cam on a yearly basis. Now, what is the path, obviously, you're going to negotiate that, but that that can help a tenant not just get smashed with these huge runaway costs. And Tyler, you say you've seen bad landlords, I would never I would never say that any my landlords would do anything like this. Obviously, they're pure as the driven snow. But some people just use cameras as a massive margin tool. Especially if you're talking about less sophisticated tenants that don't understand those audit rights and don't understand, maybe they don't have in house accounting and things like that. So that's usually something we use to keep everybody accountable is just the ability to, to not let these costs just, you know, double in a year.

7:01

Yeah, I completely agree. Adam, I'd be curious to hear your opinion on why you think retail like it is so staunchly triple net. And why you know, another asset class like Office, maybe Jesse can touch on this afterwards is so staunchly full service gross. Now that's starting to change, we're starting to see office structures very different than we used to 10 years ago. But there's kind of a dichotomy there.

7:24

Yeah, one simple way, or one simple reason I think that everything in retail skews triple net is I mean, think about you, we have a Verizon store in sweet A, right. And we have a dog washing salon and sweet Bay. And then we have a, you know, a restaurant and sweet see, and the amount of utilities that are used in those three scenarios are so wildly different. That that's one reason why it's just easier to keep everything triple net, everything's sub metered, and just keep it simple, stupid. And, you know, I think that's one of the big things janitorial really isn't a big thing in retail as well. So you just start you start stripping out utilities, you start stripping out janitorial, there's not a lot of core in a retail center, right? I mean, unless you're paying core for parking garage, things like that. So it's just not as it's not as it's not as important in retail, I guess. It's just a different way to look at it. The other thing that I see landlords and tenants get in trouble is trying to do a triple net lease and then trying to lease on leasable square footage that has the core built into it. You know, that's a big no no, in my world, I want the the rights to BOMA measure that space to make sure that if you're saying it's 2000 square feet, it's it doesn't have kind of some kind of, you know, 10 or 15% core factor built into it. Oh, and you're gonna charge me 10 bucks a foot and triple nets, you know, so

9:06

as you're double dipping? That's right.

9:09

That's right. I you know, so I've argued that facility lasciviously before and you know, it's hard to it's hard to defend frankly.

9:19

I love that word vociferously. Jesse, what about you?

9:25

Yeah, I mean, for us, I would say the lion's share 90% plus of the deals, we do our triple net deals. I think sometimes you think you have a semi gross lease, and then when you actually go into the lease document the nuts and bolts of it, there's technically a base and additional so you have to kind of watch out for that. I would say the only time we typically will do what we call semi gross, which would just be basically gross, but not including utilities and janitorial. The only time I do that is for sub leases just to keep it simple, because typically the term is going to be shorter And, you know, the sub landlord is not a professional landlord, so on. If I'm representing them, I'll just say it'll just be an easier payment flat rate every month. And then on the flip side, if I'm representing the tenant, sometimes I'll just go in for a semi gross or, you know, modified gross lease in a sublease scenario. But yeah, I'd say 95% Plus, it's triple triple net for us.

10:27

Yeah, the base rent expense staff was a really interesting curveball to me when I was first getting started in commercial real estate, because I was like, Wait, I don't understand how you figure this thing out at all. Because it's basically a full service gross triple net lease, which is hilarious to say, but that's exactly what it is. Because, you know, it's a great way for landlords who are dealing with less sophisticated tenants, to get around that confuse you lose type of thing when you're dealing with triple net structures, right? Because tenants are always like, why don't get it? Why am I paying a base rent plus additional rent? And you know, if you're doing that kind of, well, hey, the first year, it's 5000 a month, next year, we'll figure it out. Most of them have have no issues with that. So that's interesting. Yeah, at the end of the day, doesn't really matter what the lease structure is, just make sure that you are getting an attorney to review the waste and that you are protected. And that it makes sense.

11:20

One thing I'd say is the where you, you make sure you protect yourself on the additional rent piece we always try. Well, first of all, it's It's the m and TMI, that's usually the one where you could have management fees buried into there, sometimes you'll have a realty fee on top of a management fee. So you're basically paying for somebody to write a property tax check. The other thing we typically do, depending on the market is we'll control put controls on the increase in additional rent. Usually, landlords are not going to just say yes to that. But you can push back and say controllable operating expenses, so not your taxes, taxes go up, they go up, but it could be insurance. So basically having a cap on certain things that are controllable, so that you're not just getting those costs balloon year after year.

12:08

Yep, I love it. Let's talk about some of the key terms and conditions that tenants need to be paying attention to, as they are signing these leases. As we said before, in part one, every commercial real estate lease is negotiable. If you are working on a commercial real estate lease, almost every aspect of that is negotiable. There are some parts of it that a landlord will not and cannot move on for good reasons. But that's why you need to have a good commercial real estate attorney to walk you through this. Adam, we'll start with you, you know, things like rent and escalation clauses, the length of the lease security deposits, operating expenses, you know, we talked about caps on cam, you know, what are some of the most important clauses you feel like as you know, retail tenant rep you guys are having to pay attention to

12:50

on the tenant side, it really comes down to guarantees and credit, right, because a lot of our deals are very long term. It's rare, very rare that I do a deal. That's less than five years. My honestly the the lion's share of deals that I do are 10 year, and then two five year options. Typically at a set rate. Institutional landlords always push for fair market value increases on the options, tenants always push to know kind of what they're paying. So that that guarantee piece really becomes massive when you're talking about potential 10 or 20 year relationship. So that's one thing that we always end up going back and forth on ad nauseam increases, you know, it's easy to agree to three, four or 5% annual increases because the number looks so small when when you just see when you see that three, and then and then you do the compounding math over 10 years, especially now, prime real estate's prime retail space in Charlotte, you know, triple net can be you know, 50 plus even 60 plus dollars, triple net So, you start talking about 3% annuals on that, you know that that gets pretty salty pretty quick. You know, I'd love to hear some of the other guys talk about hot buttons in their world but but I mean, their retail can get so nuanced down to trade dress and signage and view corridors. And I mean, it's, it's, it's brutal. You know, how, how nuanced I mean, especially if you do like a mall lease and a triple net, or I'm sorry, a mixed use lease, I mean, these things are good sized coffee table books, and cost, you know, 10s and 10s of 1000s of dollars to negotiate so I could put everybody to sleep with all the little quirks that I've seen over the years.

14:57

Yeah, that was the funny thing when I I first got started, I was working for a developer that had a retail portfolio office industrial. And of course, as the sole and house leasing agent, I had to be the one to pour through all of these leases and figure out what the hell was going on. And yeah, but you know, they were like, you know, hey, yeah, attorneys are going to do this, but you're the broker, you need to read through this and understand exactly what's going on. Right, which Oh, man, the office leases, super boring, but relatively straightforward. We're talking like 15 to 20 pages, the industrial leases were even, like, even simpler. And we didn't have like manufacturing or anything like that. Like, once you get into manufacturing and some other, you know, aspects of industrial, it gets way more complicated. But damn, the 1015 20 year leases that we had for national tenant retailers in the shopping centers were insane. The amount of things that went into that I can't imagine how much they had to spend. Anyway, and

15:59

you see a big tenant start to push back and you have groups like, you know, for instance, large groups that sell coffee that shall remain nameless. I mean, they will beat you did on on deals and terms, and then they'll throw things at you like, like kick out clauses and sales thresholds, and things that can drastically affect your ability to sell these things on the investment market. So yeah, it's it can get it can get pretty wild.

16:35

Yeah, that's always been interesting to me. We've tried to work with a probably the very same big coffee dealer before. And could be anybody. Yeah, could be anyone, there's there's multiple, but they have like a two three year kick out clause. And you're like, the entire reason we're doing this is because we're going to build it and sell it. I can't sell that. That's not a sellable asset. Nobody's gonna want to buy that. Jesse, let's go over to you, man. What about an office space? What do you want to pay attention to when you're looking at those leases.

17:07

So I mean, very similar to to industrial, I think it depends on what your tenants doing. So for instance, like we've heard on the retail side, there's a lot goes into upfront costs and money that goes into the space, it really depends with Office today trending towards turnkey space, basically delivered, ready to go. Sometimes that's with furniture for us, the major ones are, like we just talked about with additional rent, making sure that the increases escalations are reasonable, you know, you know, like, like we just talked about here, three 4%, year after year starts getting really crazy, when you start going into years, five to 10. So want to make sure that the caps, excuse me, the escalations are our market, when it comes to deposits, it really is a function of the covenant of your tenant. So I like to be as upfront representing the tenant as as quickly as possible. So even though you might have to wait till the due diligence phase to actually provide financials for your client, if we can get that out of the way in the beginning so that we don't get so far down the road, and then all of a sudden, you have landlord, instead of asking for two months, they're asking for four or five months of prepaid rent or anything else, basically, now that they've seen the financials of the of the tenant. Aside from that, the major deal terms that we would typically look for, in terms of the actual the rental rates, a big thing right now is free rent. Some landlords are willing to do that in term, a lot of them aren't in our market. So that would be you know, if you have a five year deal, and you want four or five months of free rent, that they're tacking that on, so that they're not messing around with their net effective rents in term. So just little things like that to kind of make sure that you have covered and then understanding exactly what is not covered in the lease. So we talked a little bit about this, but you know, janitorial hydro, all that stuff adds up. So just making sure that you understand what you are paying and how many of our tenants are just like I just tell me what my full monthly cost is. So peeling, peeling, peeling at, you know, that long lease and figuring out what is the actual outlay for them? Yeah, that

19:16

there's so much of that that can be hidden in those leases.

19:18

That's one note that I think is worth talking about. Just that like give me my monthly nut kind of question. We see I think that there's a really cool opportunity in the market for kind of smaller makerspaces and taller I'm sure you see more of it in Nashville, but there's, there's not a lot of people that do it. I really like it. And you're able to do these little 700 1100 square foot boxes, your white box everything. Obviously it's done in food halls all the time. And you're just given out these like simple streamlined six month or one year leases and it's and it's not even like personally are afoot. It's like, here's your not, here's how much it is a month, you know, we're not going to spend 20 grand negotiating this lease, because if you fail, you know, it's very strict on what you can do with the space and I'll and I've got a line of people waiting to get in because there's not much like this in the market, I think that that's something that you is an opportunity both on the lease side and on the development side that we just don't see a lot of yet in Charlotte and the things that we do have, you know, they get snapped up, I mean, little 1000 square foot, second gen white box deal in a good location in Charlotte is not on the market very long. So I've seen some, some institutional, even landlords get comfortable that kind of scenario, because it's not this huge capital outlay risk every time they sign a deal. So, you know, what's my monthly? You know, what's included? Keep it simple, stupid. Where do I sign?

20:56

That's funny. I mean, you couldn't have teed me up better, because that's exactly what the wash was. Right? I mean, that's its base, six base 400 square feet, ah, we had an all in gross number, and kind of a base expense stop type of deal. And we've got 30 restaurants on the waitlist. Because we did it turnkey. You know, we've we did, we provided the hood vent, the grease trap, the three compartment sink and the walking coolers. And so because of that, I mean, you know, when when I first like started pitching it to brokers to bring us tenants, we ended up working with zero brokers on this deal, which is kind of wild, they all the restaurants just called us directly. So there's something to be said there as a landlord or a landlord. Rep. When you work on these smaller deals, you're probably double ending both into the commission. But the brokers that I talked to, they were like, we're not, that's three times market rate per square foot. We're not bringing that I was like, Yeah, but you're you're looking at it the wrong way. You're looking at it on a per square foot basis, which doesn't make any sense. This is 400 square feet. Here's what it is all in every month. That's all the business cares about. And that was all that people cared about. We had six leases signed in two weeks. So I mean, everything Adam said is absolutely right. If you do these micro units, they work really well. Chad, before we get to you, man, I realized that we completely dropped the ball on announcing the giveaway today. Should we should we do the giveaway today? What should we save it for next week?

22:25

Well, I got it right here. So let's, I think we should do it. Let's

22:29

do it today. So Chad tell tell everybody what they could be given.

22:33

Oh, see if my camera will focus on it or not, because I put it too close to my Naco. This is a custom Lego factory that I had designed by a professional Lego designer. So it's the faggus factory in Germany, built in 1913 Still looks as badass today as it did 110 years ago. I kind of wanted to have this partly as as like something to give away. Like I think it'd be a cool gift. I've had people that have already wanted, wanted to know how they could buy it, not selling it. I just am an industrial real estate nerd. This building is actually on the UNESCO World Heritage site as well. So it's like a world famous building in Germany. It's very popular in industrial real estate nerds circles like I run in, it's popular. So I've got the manual for it. The designer that I hired made a professional manual I followed it was super easy to do. It's it's pretty big, but you can get a sense of the scale on it. It's it's super detailed, like he did an awesome job on it. So I think we should I think we should give one away. Yeah,

23:37

we'll give it away today. All you have to do to enter the giveaway is just drop a comment or a question in the live chat. And we will tell you up here at the end I'll do a little screen share. We'll share the little selector wheel at random and give it away today.

23:52

The guy that called us idiots and

23:59

I was wondering if you guys saw that because I deleted it bad.

24:03

Like, I don't have time to deal with that today. Like you need to get some some energy out. So yeah, yeah, if

24:10

you're if you're listening on the podcast, somebody dropped in the live chat for idiots. I'm not gonna read the second part. There's today yeah, there's there's too much that goes into that. Chad, tell us about industrial leases man. What do people need to pay attention to?

24:29

What I've found on industrial is that the level of sophistication on either side, and I suppose is similar in retail as well really drives that narrative. If it's a small local landlord, they probably use a very straightforward template lease. If it's a large institutional landlord, they're probably using something that was developed by a top law firm, and it's elaborate. And to that extent, I've seen industrial leases be anywhere for 10 pages. To 80 pages, and you could appreciate as as you go that much higher in the lease, it just covers a lot more. And I think that that's the risk that smaller and unsophisticated tenants and landlords have is not necessarily so much what's included. But what's not included. Because if the lease is silent on an issue, it can cause all sorts of problems. And just a couple that come to mind an option to renew, if there's no option to renew, if it just isn't in there, then the tenant could theoretically be kicked out of the space at the end of the lease. If there's no right of first refusal, if there is no option to sublease, there might be case law on that there might be some areas where even if it is silent on that, there still might be some precedent. But if it's not explicitly mentioned in the lease, then that could be having to go to court to determine if the tenant has the legal right to sublease, that space. And the option to sublease. Usually it's provided, the landlord can't unreasonably withhold consent, it's usually some language like that in there. But if it's missing all of that, then then that's a potential problem. If that issue comes up, and it's silent on it, one, one that I've seen recently, as well, which is more specific to industrial, not one that's that's common in retail or office necessarily, or at least the problems don't manifest is environmental issues. So if it's a clean warehousing tenant, it's probably fine, there's very low risk of contamination. But if it's a manufacturing company, like a medium or heavy industrial use, there's, there's a reasonably good chance that there could be contamination at the end of the lease. So not guaranteed, but there's at least a chance of it. So what some sophisticated landlords are doing is they're requiring a tenant to actually go and perform a base, a standardized test at the beginning of the lease, to show that there's no contamination, or at least any indication of contamination. And then they also want to have an environmental site assessment done at the end of the lease to establish that they didn't create any contamination during that period, that becomes very tense. And it can cause a lot of problems and can bottleneck deals and cause deals to collapse altogether. Because now tenants are having to indemnify the landlord for things that might not even be in their scope. So it gets very messy, you want to start going down a rabbit hole, talk to an environmental lawyer on all the issues that can come up and how they actually trace it and how they can pinpoint it to one specific user and who's liable, that that in itself is is infinitely complex. So if landlords start trying to incorporate language into the lease, tenants, especially ones that might not be sophisticated, can be putting themselves on on a pretty big hook, where they it might be very expensive and litigious to get out of it. So I think that that underscores what we talk about often is that every situation is different. There's a lot of intricacies, it's, it's very complex, that to think somebody would negotiate a lease, without having a lawyer and a broker comment on it is unfathomable to me. And when just one extra comment on that as well, because I had this discussion with someone the other day, I think Elise can really be broken down into two sections, you've got a big section for all the business terms of the financial terms, and then the other section for the non financial terms. And perhaps that gets into insurance, or subrogation, or any of the other things that go generally beyond business terms. I think brokers should be negotiating the financial terms. And they should be very careful about talking about any non financial terms. And a lawyer should be negotiating the non financial terms, but should also be very careful if they're talking about the financial terms, because a lawyer just isn't going to be up to speed on what the market is. And if they start interjecting and proposing that this lease rate might be too high or this is uncommon. And Elise, there's no holding themselves over to be a market expert. And if they are great, I think that's can be a great value add. But for the same reason, a broker shouldn't be commenting on some of these complex terms, like an insurance clause or a waiver of subrogation broker should be very stay in their own lane and avoid holding themselves out as lawyers. So I think that that's why a broker and a lawyer should really be involved in that process. And somebody that tries to go through that process without either them they're opening themselves up for a whole bunch of risk. Well,

29:39

that is, yeah, I think that's such a good point. I mean, first of all, as a broker, why would you ever want to get involved in negotiating the insurance clause, right, like, hey, that's another clause I get to skip over the ways I'm gonna go focus on the fun stuff, right? But it's very true like you know, as as a tenant, as a business that is going to sign a lease your broker is not the end all be all. They will help connect you to everyone, but they cannot negotiate. They shouldn't be negotiating the lease on your behalf. They are not attorneys they cannot give you legal advice nor should you be taking legal advice from them unless you know it's a broker attorney in which case you found a unicorn. It's very important that you the hugest do that the right way. Guys, thanks for diving in everything today, we'll go ahead and call it a day. Next time we'll be diving into due diligence during the ways what you need to be doing before you sign the lease and also diving into the background of your landlord and property management companies so you know exactly who you're getting into bed with. I'm gonna go ahead and share my screen here so we can get to the picker wheel. That way it looks totally unbiased and has nothing to do with me. And it doesn't look like the picker wheel is necessarily showing up. Is that right?

30:54

It was there for a second.

30:56

What in the world is going on?

31:00

We'll have to go back to the really biased Oh, there it is.

31:03

There it is. I was just gonna have to pick my favorite friend that said we were all for idiots. Let's see who wins the Lego plans which is pretty cool chat. I'm gonna have to buy some of those from you because that's pretty awesome. Viken Viken has been jumping in all of my live streams lately and commenting just about every time so Vic, I'm glad you glad you got to win that. Shoot me a DM. I'll get you connected with Chad and we can take it from there. Guys. Thank you for joining me as always appreciate having you all here and we'll see y'all in the next one. Because next week, are you looking to take the next step toward investing in commercial real estate but don't know where to go? Series central offers a comprehensive education and coaching platform designed to help you get started. Our online courses cover a wide range of topics from the fundamentals to advanced strategies, ensuring you have the knowledge and skills needed to thrive in this competitive industry. As a member, you'll gain access to our exclusive online community and monthly group coaching calls, providing you with valuable networking opportunities and personalized guidance from experienced professionals. Whether you're a beginner or looking to take your career to the next level. Cre Central has the resources you need. Visit www dot cre central.com To learn more