This is the third installment of my series on commercial leases. I have noticed a general uptick in businesses (primarily new businesses) signing leases in my area. This series aims to cover the major issues that generally come up when reviewing a lease. If you need more specific help, please feel free to contact me.

Security Deposits

Most people understand what a security deposit is, but frequently, there are some misconceptions about how it should be used.

As a tenant, you will have to pay a security deposit. Generally, the amount is equal to one or maybe two months’ rent. The deposit is meant to be held by the landlord and applied to any unpaid expenses incurred by the landlord in connection with the tenant. The most common use of the security deposit is to fix the damage that the tenant left when they vacated the space. It can also be applied to any unpaid rent.

I think the biggest misconception about security deposits comes from landlords assuming that they get to keep the deposit. I have seen many conflicts arise because a landlord willfully withholds a security deposit after a tenant vacates a space. The fact is that if the tenant is not in default, the assumption is that the security deposit should be returned. If any of the deposit is used to repair damage, I think the repairs should be well documented so that the tenant knows exactly where their money went. This would really cut down on conflict.

Common Area Expenses

Common area expenses are paid in addition to rent for the upkeep of the common areas of the building. The landlord has to maintain the outside areas of a building, like parking lots and sidewalks, and it has to maintain shared interior space like bathrooms. Therefore, landlords generally charge additional fees to cover these expenses.

The normal way to divide common area expenses is to total the expenses and divide them among the tenants based on their pro-rata share of the floor space. The share is usually a percentage of the tenants leased space as compared to the entire building. Therefore, if you lease 20% of the building, you pay 20% of the common area expenses.

This system may or may not be fair depending on the building. If, for example, you run an insurance office next door to a restaurant, it might not be fair to divide the cost of garbage removal based on square footage because the restaurant most likely generates much more garbage than the insurance office per square foot. However, if the tenants are similar, a standard percentage is usually easiest.

The important thing to understand as a tenant is what your actual costs will be. If you are told the rent will be $1,000/month, that likely does not include common area expenses or taxes. Therefore, you will need to know those costs in order to actually budget for the cost of the space.

Taxes

Taxes are usually divided like common area expenses, with each tenant paying a pro-rata share. Normal tax costs cover the standard real estate taxes for the building. This number can change from year to year based on the tax assessment so it’s important to understand how the building is being assessed.

But tax cost can (and usually does) include the cost of any special assessments or costs imposed by a governmental agency. Like many other costs associated with owning a building, the individual tenants may not reap many benefits from special assessments because of the short-term nature of their leases. Therefore, paying special assessment taxes is usually a cost with very little gain.

Just like I mentioned with common area expenses, as a tenant you need to know what the costs of renting the space will be. Rent normally does not include these additional costs so you need to budget for these items, as well.

Insurance

All leases require the tenant to obtain insurance. This is more than just renter’s insurance. They will want the tenant to obtain liability insurance to cover any claims that may occur on the premises. This is a standard provision. Normal insurance coverage is $1,000,000 in liability coverage. Personally, I think this amount is extremely high for most businesses, but it’s the standard commercial policy.

The tenant will need to add the landlord as an additional insured on the policy. Again, this is standard. The landlord doesn’t want to have to pay for an injury that occurs in your space. If someone is to fall in your space, they will likely sue everyone. This isn’t because personal injury attorneys are evil. Rather, it’s just how the system works. Therefore, everyone will want insurance coverage.

Standard commercial policies are not very expensive, and frequently they include provisions that are a benefit to the tenant. For example, many policies include coverage for theft and fire, and some cover errors and omissions, as well.

Next Time

In my next article on commercial leases, I plan to cover use, maintenance and repairs, and subleasing. Please feel free to contact me with any additional questions.