What is a Commercial Lease Agreement?
Commercial Lease Agreements in North Carolina are written agreements between a landlord (lessor) and a tenant (lessee), in which the landlord agrees to provide a property to the tenant for the tenant’s use and occupancy, in exchange for rental payments for a specified duration. Commercial leases in North Carolina tend to be considerably longer than residential leases, may cover hundreds of pages and even be negotiated by attorneys, which reflects the complexity of the scope of activity contemplated, the coordination of multiple spaces in a multi-tenant project, and the financial value of a long-term agreement of often more than five years and possibly much longer.
A commercial lease may be a simple agreement to lease an office for several years at a specific rent. Or it may be a complex multipage document that covers 50 , 100, or even multiple hundred pages, with an outlet for each tenant in a multi-tenant shopping center. Moreover, the lease may include a guarantee from a parent or grandparents’ company to ensure performance. The vision and planning behind commercial lease transactions is unique and takes into account the layout of the building, the amount of square footage, and the amount of rent to be paid. Considerations also abound as to additional terms of the lease, including shared expenses, common areas, tenants’ rights, obligations, restrictions, and lease term.
Commercial leases differ from residential leases in scope, complexity, and duration. A commercial lease may also be modified or supervised by the landlord’s attorney or a real estate broker.
Essential Components of a Commercial Lease in North Carolina
How long do you intend to lease the premises? Almost as important as how much you will pay in rent is the term for which you will lease the property. The term should conform with the length you plan to use the space. If you only need it for a year or two, ask for a shorter lease term. If your business will need it longer, it’s not wise to enter into a one-year lease that may end when you’ve finally spent the time and money necessary to make it successful. The lease term must be in writing for the protection of both parties to the agreement. The lease should contain an automatic renewal clause to avoid termination at the end of the lease period, typically unless otherwise terminated by either party. It’s best to have the lease state the renewal date, usually 90 days prior to the lease period ending so that the tenant and landlord can consider whether the lease should be allowed to end or extended. Lease terms are usually steady for the entire period, but the parties may agree to adjust rent at times during an extended lease. The lease should state how much rent you will pay, when it will be due, how it will be paid and where. Rent is typically paid monthly on the first day of the month. The lease should specify where you will send your rent check and who will receive it. If you pay by automatic electronic funds transfer or through a payment service such as PayPal, the lease should state that as well. It’s important to examine the rent amount specified in the lease thoroughly. The lease should state specifically whether it covers only the space you will occupy, as in the case of a standard lease, or a pro rata share for the entire building. You may be responsible for common area maintenance such as landscaping and parking lot maintenance in addition to the space you occupy. The lease should address any surprise charges that might come up, such as cost-of-living increases, or "pass-throughs," when expenses relating to property expenses or property taxes are passed-through to the tenant. The lease should also not assume that space in the building such as common area restrooms, stairwells and elevators is included in the tenant lease space. It’s critical that a tenant understand specifically what space is being leased to them and whether they must also contribute to the cost of maintaining common area space in the building.
Types of Commercial Leases in North Carolina
In North Carolina, there are four main types of commercial leases of real property:
a gross lease, a net lease, a net-net lease, and a net-net-net lease… Typically in three-part, sublease form.
1. Gross Lease
With a gross lease, the tenant pays one, simple rental amount to the landlord on a periodic basis. The rental price is generally based on the overall value of the property, and does not vary over the term of the lease. In the gross lease, the landlord is responsible for paying all of the property expenses to maintain the property, such as insurance, taxes, maintenance, and repairs.
2. Net Lease
While the net lease can take different forms, in most cases, it refers to a lease in which a tenant pays a monthly rent to their landlord that is lower than a gross lease, but that is net of all taxes, insurance, and maintenance costs. The net lease shifts many of the property expenses that are traditionally included in a gross lease over to the tenant. The terminology may vary, but essentially there are three types of "net" leases:
3. Net-Net Lease
In addition to paying the typical lease rent, a net-net lease requires that the tenant pay the property taxes and maintenance costs to the property. In this case, the tenant and the landlord share responsibility for paying the property expenses.
4. Net-Net-Net Lease
The net-net-net lease is similar to the net-net lease in that the tenant is required to pay all the usual operating costs to the property. However, in a net-net-net lease, the tenant is also obligated to pay any capital expenditures. The net-net- lease is relatively rare.
Legal Obligations for North Carolina Commercial Leases
The legal requirements for drafting and enforcing commercial leases in North Carolina are established by common law and a few statutes. Courts in North Carolina have long recognized the need for these agreements to be specific about the costs of occupancy. Consideration is at the heart of any contract. Here, it is the rent for the use of the premises. Only if there is valuable consideration – something that makes the deal attractive to both parties – will a court require performance from either party.
Under the statute of frauds, for a commercial lease for a tenant for more than three years to be enforceable against a third party in North Carolina, the lease must be in writing. While North Carolina courts have never been asked to determine whether a commercial lease is equitable in nature and therefore not subject to the statute of frauds, it is reasonable to conclude that if a lease grants to a tenant some advantage on the premises (and not merely a right to use the premises), it would be enforceable against a third party in the same manner as an option.
Under the statute of frauds, for a lease of less than three years to be enforceable against a third party, the lease must be signed. If the lease is not signed, it may still be enforceable if the tenant takes possession and pays rent. The tenant’s possession and the landlord’s acceptance of the rent payments may indicate an intention to be bound by the agreement.
While there is no particular state statute governing security deposits in North Carolina, each of the four major metropolitan areas has enacted a Rental Security Deposit Law. Each statute limits the amount of the security deposit that may be collected by the landlord and the circumstances under which the money may be used. Depending upon the size of the promised repairs, landlords should consider specifying the size of the repairs that will be made before the deposit is accepted (in which case a check will be required), the length of time anticipated for the repairs to be made (in which case an escrow clause will be necessary) and the maximum amount that will be spent on the repairs (in which case a chapter 75 clause will be necessary).
Common Issues and Remedies for Commercial Leases in North Carolina
Understanding Commercial Lease Agreements in North Carolina
The negotiation and implementation of commercial leases in North Carolina can be fraught with challenges for both landlords and tenants alike. One of the most common areas of contention is the allocation of maintenance responsibilities for fixtures, common areas, and utilities. This often stems from the ambiguous nature of the terms "reasonable care" and "normal use." Tenants may want to shift the burden of maintenance and repair onto the landlord, while landlords seek to protect their investment by placing as much responsibility as possible on the tenant. A clear definition of the specific areas of maintenance and repair, as well as a schedule (if applicable), within the commercial lease agreement can help avoid future disputes and save both parties money and time. A second major issue owners and landlords face is the lack of knowledge tenants may have about the intent of certain lease provisions. For example, landlords often believe that tenants understand their responsibility to obtain appropriate licenses to conduct business, but this is not always the case. The commercial lease should contain a clause that places responsibility for securing such licenses on the tenant. Similarly, the lease should include a brief sentence regarding compliance with zoning code(s) in order to protect the landlord from liability and/or costs associated with non-compliance. Another potential hurdle that can cause frustration , confusion, and additional costs for the parties involved relates to subleases. Failure to include subleasing terms or applicable language in a lease can lead to future issues. For example, the commercial lease should stipulate how rent payments will be distributed when the tenant subleases the property to one or more tenant(s). Furthermore, a commercial lease agreement should contain specific eviction procedures, including grounds for immediate eviction. Lacking this information, a landlord may face difficulties evicting a tenant who is not paying rent. Conversely, it is not uncommon for a tenant to try to "wait out" a landlord who breaches a commercial lease agreement by withholding rent until the landlord makes necessary repairs. (A tenant cannot generally withhold rent as a form of self-help.) Many of these issues can be avoided by consulting with an attorney and having a commercial lease drafted by a qualified legal professional. In addition to having a general attorney familiar with real estate law, Ragsdale Ligget advises clients to seek counsel from our Land Use and Zoning practice group when negotiating new leases. Over the years, we have developed a great working relationship with many municipalities across the state and can help our clients who are seeking a new commercial lease agreement to avoid conflicts during and after negotiations.
Negotiating a Commercial Lease in North Carolina
It is critical that the parties (and their respective counsel) come to the table with a clear picture of what they hope to achieve. Without this, even the most seasoned real estate lawyer will have a difficult time selling it to the landlord and tenant. Some terms may not be negotiable. The landlord may refuse to make any changes. The market may be tight, and perhaps the tenant has to take the lease "as-is" regardless of whether this is fair. As a result, an effective strategy for negotiating a commercial lease in North Carolina starts with knowing your priorities and being able to walk away if you do not achieve your desired result.
First, determine what the key lease provisions are to you and the other party: rent, term, condition of premises, use, assignment and sublease, security and tenant improvements. Without this list, there is no point in having the negotiation conversation at all. Second, know ahead of time what is important to you or what you absolutely cannot accept. Rent increases around 5% are generally the norm, but if you are budgeting a set increase each year and seek to avoid a large effective rent increase, then you want the rent increases capped at some level, below the anticipated market rent at the time each increase shall become effective. Third, understand the market. The savvy tenant should know what the average rental rate is for similar property in the same location, what landlords offer for tenant finishes and how they amortize the cost, and what incentives landlords offer to encourage tenants to take space. Finally, be prepared to compromise.
Negotiations take place between the parties and are ultimately premised on voluntary agreement. The landlord holds a valuable piece of property that will likely generate income for the next 5 to 10 years. If the tenant cannot reach an agreement, the landlord can walk away and find another tenant. The tenant, on the flip side, has time and money invested in negotiating the lease, not to mention relocation expenses if the negotiations fail. Therefore, most tenants will ultimately agree to terms they do not totally prefer, simply for the sake of arriving at an agreement in order to move on with the other business of the day.
Ending and Renewing Commercial Leases
In North Carolina, a commercial lease may be terminated upon expiration of its stated term or upon a date provided for in the lease for earlier termination. During the lease term, the commercial tenant has a property right entitling the tenant to exclusive possession of, and title to, the premises. Normally, a commercial lease contains a provision for early termination if the commercial tenant is no longer able or willing to pay rent. The lease may also contain a provision allowing for early termination by the landlord if the tenant is in default or has failed to comply with applicable laws. For residential tenants, termination of a lease is governed by the Residential Rental Agreements Act.
In North Carolina, a written commercial lease for five years or longer must be recorded in order to provide the greatest third-party protection for the commercial tenant. A lease that is not subject to the statutes of fraud (that is, for a period of one year or longer) may be terminated in writing by either party, or it may be terminated orally by agreement of the parties . However, the cutting off of the landlord’s expectation of rentals could be powerful evidence, if it occurs without the formalities for termination provided in the lease or by the common law.
If the lease provides for a renewal at the option of the commercial tenant, it is best if notice is given within a reasonable time prior to the lease term. A lease may simply provide for automatic renewal for a stated term or until the landlord requires the tenant to vacate. A lease is renewed when the tenant holds over with the landlord’s acquiescence. Commercial leases will normally provide for the mechanic for renewal — a simple extension of the term, or a new full-term lease on new terms and conditions. There are no penalties for holdover by a commercial tenant and the landlord cannot hold the tenant for a period of time beyond the term unless it is made secure by a bond or other security, even if the parties have terminated their lease by a written instrument.