Intro to Lease Clauses: For the Landlord

Over the course of the next several weeks I’m going to discuss various lease clauses that should be included in commercial leases. But, as a lagniappe -– and as a way to find out if anyone is even paying attention -- like Click and Clack on Car Talk -- this week I’m going to include a puzzler that won’t be answered until next week. And for anyone who answers via a comment, you’ll have the psychic pleasure (or sadness) of learning whether you are right.

The question: Why are manhole covers round?

Now, on to the lease clauses. This week’s post will focus on those of importance to landlords.

First, of course, as a landlord, you need to decide what kind of lease to offer. There are three types customarily used in commercial leasing, namely,

a “full-service lease,” where the tenant pays basic annual rent but does not pay for any operating costs;

a “triple net lease,” where the tenant pays basic annual rent plus a pro rata share of the building’s operating costs and real estate taxes;

and a “base year lease,” where the landlord pays all operating costs and real estate taxes associated for a specific year - the “Base Year,” which is generally the first full calendar year following execution of the lease or the calendar year in which the lease is executed. The tenant pays a pro rata share of the increases in the building’s operating costs and real estate taxes for each year during the term following the Base Year.

Retail leases can also include percentage rent (i.e., a percentage of a retail tenant’s sales from its premises) but that will be a subject of a future post.

Second, landlords need to decide how Basic Annual Rent will be increased during each year of the lease term. Typically, increases can be based on a fixed percentage increase or tied to annual increases in a fixed benchmark, usually the Consumer Price Index (CPI).

If choosing the CPI, the landlord needs to be careful which CPI to use because there are several, e.g., the “All Urban Consumers” Index (“CPI-U"), the “Urban Wage Earners and Clerical Workers” Index (“CPI-W”), and the “CPI-U, US City Average, All Items”; these indices are available to measure both national as well as regional trends. Regional indices tend to be more volatile than the national indices but may be more indicative of inflation in the area where the building is located.

Another decision when using the CPI is whether a rent increase should be equal to 100% of the corresponding increase in the CPI or be a fraction of the CPI. Market factors will generally drive that decision.

And, finally, when using the CPI, there should be a concomitant minimum increase regardless of the increase in the CPI. But what’s sauce for the goose is also sauce for the gander - if a minimum is imposed, landlords should expect tenants to ask for a maximum cap regardless of the corresponding increase to the CPI.

Landlords should always include a provision that limits their possible liability for any type of claim made against a landlord to the landlord’s equity interest in the building. The personal assets of the principals of the landlord should not be placed at risk.

Next week I’ll discuss lease clauses of importance to tenants -- and answer why manhole covers are round.