Understanding Commercial Leases

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Understanding commercial leases.

When you’re looking to invest in commercial property, leases are very important if not, they’re the holy grail of commercial property investment. Sometimes you can go, but there’s so many other parts like property itself, the industry, the tenant, really, when it comes down to it, commercial property for lease is such a core function. 

Now if you’re trying to understand what should I be looking for in a lease? There’s so many parts that involve different partners. Example, your buyer’s agent, your lender, and even your lawyer. But if I talk about high level, what are some things to look at to generate the right investment result?, let’s go through those things now. 

Number one is the end amount. The dollar, right? That’s very important in terms of how much is your return on the investment you’re putting together and with that return, can you understand from the dollar if that’s a net or gross, because that leads to point number two, the structure of the outgoings.

Who’s paying for what? Is the tenant paying for a lot of the stuff or are you paying for a lot of the stuff? And when you can get that distinction, you start to understand the money out from this investment and the money in that you expect to receive. 

The next point is around lease length. Now, lease length can be a little bit confusing, because you can’t just look at it and say that’s the end date, as there are things like options and you know renewal periods and when you consider those it might be a two by two by two but that doesn’t mean it’s a six year lease. It means it’s a two year lease and there’s an option for the tenant to review renew it at similar terms then another two year lease in another option for the tenant to renew it at another similar terms. So that really shows you the variants in the lease and something to consider from that.

Next is the regarding the actual fit out and maintenance and improvements on the property. Now if you’re looking to do that, it’s important to understand who carries what role. Sometimes, there’s leases that involve the tenant being responsible for certain fit outs or bringing the property to its original condition at the time of lease. Sometimes, it’s up to the landlord and the landlord needs to provide these changes. I’ll actually even seem leases where the landlord needs to paint the property or restructure the property or renew the property in certain areas every few years. Now you can imagine that can take a toll on your outgoings, but on the plus side it may also help keep the condition of your property.

So, another thing to consider is actually around the security. There’s so many ways to secure residential property. There’s actually one key way, really. It’s the bond. So if you’re thinking of your bond on the deposit for the renter, what’s the equivalent in commercial? 

There’s two core ways that stick out. Number one is something called a bank guarantee. It’s similar to a bond actually, but the core difference is instead of your say, four week rent, you’re looking at three months, six months, and I’ve even seen some beyond that. What it is is the tenant putting away a security deposit with the bank and the bank issuing a document to say that this security deposit is held safely with them and for the business there in case the landlord has something come up or the tenant has something come up, the landlord can access that where need be. 

Now other types of security guarantees are personal guarantees. This is when the director is saying they’re personally liable for the actual lease in place in case something were to occur. Sometimes it’s actually considered stronger from the personal guarantee, but there are sort of processes to go through in terms of claims processes that come up, whereas with the bank guarantee they’re usually more black and white, if cash is sitting there and you’re aware of how much that will really come into play. 

So those are some of the core components of a lease. But other things to consider if you are making changes to a lease or rewriting the lease, they actually do end up being costly processes. They aren’t similar to your rental leases for residential where you can print things online or get your property manager to make a few tweaks. There are actually legal processes involved which review them, because really each business is bespoke and each condition could be different for another business. 

So when you look at these things, legal reviews, lease terms, dollar amounts, net rent and expenses, maintenance and improvements of the property, and a few of these other key points that I mentioned, they really helped you analyze the strength of the lease and what’s involved and what’s available for you to do when it comes to purchasing this commercial property. 

There are a few other components, but I’ll save that for another video. And also, you can reach out to me if you’d like to discuss that in more detail. 

That’s it from us here at InvestorKit: the experts in wealth creation, helping you take action