If you own a warehouse, retail space, or another commercial building, you may be wondering what to do with your commercial property. Instead of letting it sit vacant, renting it out can generate steady income.
The commercial lease process involves making key decisions, from selecting the right lease type to setting competitive terms. Use our guide to learn how to rent out your commercial property successfully.
Step 1 – Decide Whether to Use a Broker
Decide how you want to lease your commercial property. You can do it yourself, although it may require a lot of time and effort researching real estate laws and regulations. Alternatively, you can hire a real estate broker to manage the process. A broker will charge a certain percentage of the rent as commission, but this expense may be worth it for commercial landlords who want a more hands-off approach.
Step 2 – Select a Lease Type
During the initial strategy phases, you can decide what lease to seek with a commercial tenant. Common commercial lease types include gross, triple net (NNN), modified gross, and percentage leases. Study each type and think about how flexible you want your monthly costs to be.
For example, you can enter a gross lease if you prefer to handle things yourself. In this lease, you charge the tenant all-inclusive rent and cover most expenses as the landlord. If you want to reduce your management responsibilities, you can create a triple net lease. This lease shifts property taxes, insurance, and maintenance costs to the tenant.
If you’re willing to share the risks with tenants, you may consider a percentage lease. This lease lets you charge base rent and a percentage of the tenant’s sales. If they perform well, you can reap financial rewards, but you may experience income loss during business downturns. Consult a broker if you have questions about the right type for your situation.
Step 3 – Make Legal & Regulatory Considerations
Before leasing your commercial property, ensure it’s legally ready for occupancy. This step helps you avoid liability and delays. Key considerations include:
- Zoning compliance: Confirm that your property is zoned for your prospective tenant’s business type. For example, a retail business may not be allowed in a property zoned for industrial use.
- Required permits: Verify that you have all the required building and business permits for your property.
- ADA compliance: Confirm that the property meets Americans with Disabilities Act (ADA) design standards, including entrances and parking spaces.
- Environmental concerns: Some properties may require environmental assessments, especially if the tenant’s business involves hazardous materials.
- Fire and safety codes: Make sure the building complies with local fire and safety regulations, such as working fire alarms and accessible emergency exits.
Consult a real estate attorney or local permitting authority to ensure you cover all the legal bases.
Step 4 – Set Boundaries for Tenant Improvements
When you rent to commercial tenants, they may have ideas on how they want to convert the space to meet their business needs. Evaluate your property and its current layout to decide if you will let tenants make improvements. You may offer the tenant a tenant improvement allowance (TIA) so they have the funds to make repairs or modifications.
While you may reduce your initial cash flow, allowing tenant improvements can be beneficial in the long run. Permanent tenant improvements that are part of the building can become the commercial landlord’s property. These improvements can increase your property’s value and make it easier to rent out in the future.
Step 5 – Conduct Market Research & Evaluate the Property
Before listing your commercial property, you should know what similar spaces are going for. Look at comparable properties in size, condition, location, and amenities. Local brokers and online commercial listing platforms can offer valuable insights.
Be honest about your property’s strengths and weaknesses. If it’s in a high-traffic area with recent upgrades, it may command higher rent than a property that needs repairs.
To support pricing decisions, familiarize yourself with key metrics like:
- Capitalization rate: Assesses a property’s return based on income and value.
- Net operating income (NOI): Your income after expenses but before debt service.
- Vacancy rate: High vacancy rates may lead you to consider lease incentives.
Step 6 – Set the Lease Rate
Before you get into negotiations, you can do some math to get a solid estimate of your rental rate. Learn how to calculate commercial property lease rates:
- Determine the price per square foot (PSF): Work with your broker to determine the PSF. Market conditions (which you found in the previous step) can help determine the PSF.
- Measure the total square footage: Distinguish between usable square footage (USF) and rentable square footage (RSF). USF is the area the tenant occupies, while RSF is the USF plus common areas. Commercial landlords often use the RSF to calculate rent costs.
- Calculate the rent amount: Multiply the PSF by the RSF to get the total rent amount. Divide this figure by 12 to get the monthly rent.
- Consider lease structures: Determine whether the commercial landlord or tenant will cover expenses like taxes and insurance. You can factor these additional costs into your rent amount.
Determine a base rental rate you won’t go below. This minimum should account for your operating expenses and income goals while remaining realistic for your market.
Step 7 – Market the Property
Once you work out these initial details, you can write a listing to market your property. For visibility, use online platforms like LoopNet and Crexi.
Depending on the type of commercial property you lease, you can highlight different features in your listing and emphasize what makes the space valuable. For example, if your property includes a commercial kitchen, market it to restaurant owners. If it has loading docks or warehouse access, emphasize those features for shipping companies. When you’re specific in your listing, you may be more likely to attract serious, relevant inquiries.
Know Your Property Class
Commercial properties are often grouped into Class A, B, or C based on age, condition, location, and amenities:
- Class A: Newer, high-end buildings in prime locations with top-tier amenities. Highest rental rates and the most competitive market.
- Class B: Older but well-maintained properties in decent locations. More affordable and appealing to mid-size commercial tenants.
- Class C: Older buildings in less desirable areas. Lower rental rates but potentially higher yield in underserved markets.
Understanding your property class helps you set realistic expectations and tailor your marketing to the right group of commercial tenants.
Step 8 – Prescreen Tenants
Standard commercial leases often range from three to ten years, so it’s essential to find a reliable tenant who can fulfill long-term obligations. Screening tenants thoroughly can lower the risk of missed rent payments or early lease termination. Request the following documents to properly vet tenants:
- A completed commercial lease application
- A photocopy of their driver’s license
- Bank references
- Credit reports
- Employer Identification Number (EIN)
- Previous or current landlord references
- Personal and corporate financial statements
- A copy of the business plan
- Business bank statement(s)
- Prior tax returns
Step 9 – Conduct Showings
Once you screen interested tenants, you can schedule property showings. You or your broker can walk the potential tenants through the property. The person showing the property should help potential business tenants visualize how the space fits their needs. Bring a leasing brochure or another document that has key information:
- Floor plans
- Zoning information
- Nearby businesses or attractions
- Parking availability
- Operating expenses/utility costs
- Rent terms
- HVAC, plumbing, or electrical specs
- Internet connectivity
- Security systems or building access hours
- Maintenance responsibilities
Before a showing, ensure the space is tidy, well-lit, and clutter-free. If the space is completely empty, tenants may have a hard time imagining its use. Consider filling it with basic equipment or furniture to make conceptualizing it easier.
Step 10 – Negotiate Rent & Other Terms
Get ready to negotiate, as the tenant will want to find the most suitable rental terms for their business. Your tenants’ needs can influence the negotiation, so be mindful of their business type and space requirements. Be open to discussion, but know your property’s strengths so you don’t undersell it. Consider your expenses, such as mortgage payments and property taxes, to ensure you make enough rental income.
Once you solidify the rental rate with your tenant, you can negotiate other terms, such as:
- Security deposits
- Lease term and renewal options
- Early termination clauses
- Subleasing and assignment rights
- Right of first refusal clauses
- Exclusivity clause (to prevent competition with the tenant)
- Common Area Maintenance (CAM) caps
Write a Letter of Intent
Write a letter of intent to enter a commercial lease. This preliminary document lets you record all key details without entering a binding contract.
Common Commercial Leasing Risks & How to Avoid Them
Leasing a business space doesn’t come without risks, but you can avoid them in the following ways:
-
Risk: Tenant defaults on lease
- How to Avoid: Require a personal guaranty or a larger security deposit.
-
Risk: Tenant files bankruptcy
- How to Avoid: Include lease termination clauses triggered by bankruptcy.
-
Risk: Unexpected repair costs
- How to Avoid: Clarify who handles maintenance and cap CAM charges.
-
Risk: Legal disputes
- How to Avoid: Add arbitration or mediation clauses to resolve issues efficiently.
-
Risk: Vacancies
- How to Avoid: Consider shorter initial lease terms or step-up rent clauses.
Step 11 – Execute the Lease
Once both parties agree to all terms, you can draft and sign an official commercial lease with Legal Templates. It’s a good idea to have a lawyer from each party review the lease before signing and renting out commercial property. This ensures that qualified legal counsel can ensure fairness. Upon signing, each party must fulfill its obligations in the lease.
As the commercial landlord, you can collect required documents and payments, such as the security deposit and first month’s rent. You may also need to acquire proof of general liability or business insurance.
Let the tenant move in by granting adequate property access. Depending on your terms, you may need to coordinate utility set-up or modifications.
Maintain clear communication throughout the lease to address any issues in a timely manner. If the tenant breaches the commercial lease, you can issue a notice requesting a correction or take legal action to get them off the property.
How to Maximize Return on Investment (ROI)
One of the easiest ways to maximize your return on investment (ROI) when renting commercial space is to establish a long-term rental period. You can incorporate built-in rent escalations to ensure you don’t miss out on higher returns over the years. Other ways to maximize your ROI include the following:
- Capture long-term appreciation: A well-located, high-demand property can grow value over time, especially if you hold it long enough to benefit from market appreciation in an economically up-and-coming area.
- Take advantage of tax benefits: You can deduct mortgage interest, depreciation, property taxes, and operating expenses from your taxable income. These deductions can increase your after-tax ROI.
- Benefit from tenant improvements: When a tenant updates your business property rental (with your authorization), you can gain upsides that future tenants may find appealing.
-
Monitor market trends: Consider refinancing, selling, or reinvesting profits.
- Refinance at lower interest rates to reduce debt costs.
- Sell when the commercial property has appreciated to lock in gains.
- Reinvest profits into other properties through a 1031 exchange to defer capital gains tax.
