Net Lease Lessons
When the jury was still out on your business’ survival, you probably didn’t want to enter into any long-term contracts.
But if you’ve survived the last five years, now might be a good time to take a serious look at your long-term real estate requirements to endure location continuity for customers, plus operating expense control.
Long term means either direct ownership or a lease of someone else’s property. Let’s focus on the lease option today.
Long-term leases are typically at least three years or more and are necessarily more sophisticated. The first evidence of sophistication will be found in how the tenant pays for the space.
Instead of just making an all-inclusive, fixed monthly rent payment, in a long-term lease some or all of the property’s operating expenses are allocated to the tenant.
Called a “net lease,” here are some guidelines of three basic variations:
- A single net lease includes the basic monthly lease payment, plus a limited number of operating expense items, such as property insurance or tax, for example. The key distinction is that some financial obligation other than a fixed lease payment is required of the tenant.
- A double net lease has a monthly leas payment, plus all operating expenses except exterior maintenance, such as the roof.
- A triple net lease has all the elements of a double net, except the tenant pays all operating expenses, including all maintenance.
Of course, the more “net” obligations the tenant accrues, the lower the fixed payment.
You can compare long-term lease options by converting all lease expenses to annual square-foot rates.
Divide the total annual lease expense by the interior square footage of the space to get the annual square-food rent rate. The dollar amount in this equation must include everything the tenant is obligated to pay: the basic annual lease payment, insurance, taxes, etc.
For maintenance, come up with an estimate based on the age of the property and its systems. And you can decide if utilities and future inflation increases should be included. Then, add up all annual expenses and do the math.
Using this method, you can compare different types of leases, properties, maintenance levels and square footages in much the same way the handicap system allows golfers of different skill levels to compete against each other.
Unlike the basic monthly lease payment, insurance, taxes and maintenance each hit you with one big bill. And while taxes and insurance are mostly predictable, maintenance and repairs aren’t. Establish a monthly reserve so you have the cash when the annual expenses occur and to cushion the blow when the roof leaks or the air conditioner goes out.
Finally, even if you think you’re an expert on leases, consult with your attorney and CPA before you sign.
Write this on a rock... Make sure you know what you’re doing before you sign a long-term lease. Surprises are for birthdays, not business.
Jim Blasingame
Small Business Expert and host of The Small Business Advocate Show
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