Pros and Cons in Buying or Leasing a Commercial Real Estate

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 Buy or Lease? Commercial Real Estate Pros and Cons

Commercial real estate law is the set of laws under the umbrella of property law that regulate the sale and transfer of properties for business use. Importantly, the exact laws concerning commercial real estate and the buying and leasing of properties will vary from state to state. There are also several different types of commercial leases that a business owner may choose to enter into with a landlord.

Examples of the most common commercial leases include:

  • Fixed Leases: A fixed lease is a lease that is similar to a common residential lease. In a fixed lease, both parties agree to a specific amount of rent that is to be paid for a fixed period of time;
  • Step Leases: A step lease is a lease in which the parties agree to increase the rent by a certain amount yearly.
    • Step leases are meant to acknowledge the potential cost increases that the landlord may incur, but often do not take into account the cost of business, or rising costs of business, experienced by the tenant; and
  • Gross Leases: A gross lease is a lease in which the tenant will pay a set periodic or fixed term rent to the landlord. Further, in a gross lease the landlord typically agrees to pay for some or all of the business’s operating costs.

It is important to note that residential leases and commercial leases are not the same. Examples of differences between residential and commercial leases include:

  • Negotiated Terms: Parties to a commercial lease will commonly negotiate the terms of the lease and tailor the lease to an agreement reached in a negotiation. In contrast, parties to a residential lease will generally sign a “form lease” with no negotiations as to terms;
  • Length of Lease: Parties to a commercial lease generally agree to longer lease terms in order to avoid the disruption of businesses and keep the costs associated with the lease fixed. In contrast, residential leases are typically for a short period of time, such as 1 year; and
  • Eviction Procedure: The procedures for commercial eviction vary drastically from that of residential eviction, and will be dependent upon local state laws concerning timing.

A significant percentage of commercial real estate transactions involve legal disputes concerning selling and purchasing property for commercial use. Although long term leasing is an option for a commercial business, many businesses choose to purchase the property in order to fix the costs associated with the use of the commercial location, and to build equity in the property.

As such, there are many lawsuits involving legal disputes concerning selling and purchasing property for commercial use, such as disputes involving:

  • Property and land use;
  • Liquor licensing; and
  • Local zoning issues.

For example, the majority of state and local property laws prohibit business activities from being conducted in residential areas. Additionally, many state and local property laws also prohibit residential areas from being erected in areas zoned for commercial use. As such, many prospective commercial property owners may seek to challenge a local zoning code in order to acquire land in an area for commercial use.

Factors Whether to Buy or Lease Commercial Real Estate:

There are numerous factors that a prospective commercial property owner should consider when deciding on whether or not to buy or lease commercial real estate. Examples of common factors that a business owner should consider include:

  • Whether or not the business owner has access to funds or credit necessary to purchase commercial real estate;
  • Whether or not the business owner is seeking to secure a short term or a long term location for their business;
  • Whether or not the area in which the commercial real estate is located is in an area that is growing in property value or has a risk to decrease in property value;
  • Whether or not there will be commercial property legal issues associated with the piece of commercial real estate property, such as the need to secure a private right-of-way (i.e. an easement) or zoning issues; and/or
  • Whether or not the commercial real estate is located in an area easily accessible by customers or resources necessary to the business.

Types of Commercial Leases

As mentioned above, the three most common types of commercial leases are:

  • Fixed Leases;
  • Step Leases; and
  • Gross Leases

However, when determining what lease may be the correct lease structure for one’s business, a prospective commercial lessee should also review the commercial lease terms. Examples of common lease terms that a prospective commercial lessee should review include:

  • Length of lease term;
  • Cost and structure of rent and how rent payments are to be made;
  • Any additional costs that may be associated with the lease, such as maintenance of the property or the payment of property taxes;
  • Whether or not a security deposit is required, and whether that security deposit is refundable or not refundable at the end of the lease term;
  • Whether or not the property is able to be improved or modified in order to expand or conduct business activities on the property;
  • Whether or not the lessee (i.e. the commercial tenant) is able to sublease the property; and/or
  • How legal disputes concerning the property are to be resolved, whether it be by arbitration or another form of dispute resolution.

Commercial Leases vs Residential Leases

The main differences concerning commercial leases and residential leases were discussed above. However, there are pros and cons of commercial real estate law claims. For example, a landlord and a tenant may choose to have either a residential or commercial lease. However, any property utilized in a commercial lease must be used for business purposes only. This means the commercial tenant cannot enter into a commercial lease and choose to live on the property in most cases.

Further, although the exact laws concerning tenancy vary from state to state, tenancy laws are typically based on the respective power of the parties that negotiate the lease. In a residential lease, tenants have special legal rights that ensure that the property is both habitable and that problems associated with the habitability of the property are timely fixed. These laws are typically enacted as a result of most residential tenants not having much bargaining power when negotiating a lease.

In contrast, commercial tenants are assumed to be more knowledgeable about business and real estate laws than residential tenants. This means that commercial tenants are not given the same legal protections extended to residential tenants. As such, it is harder for a commercial tenant to successfully sue the landlord for disputes involving a commercial property.

However, as noted above, commercial lease agreements are often more negotiated and flexible than that of residential leases. As such, it is important to include and review the section of the lease concerning disputes over the property.

Buying Commercial Property

As mentioned above, when considering purchasing commercial property, a prospective commercial property owner should consider numerous factors. In addition to the factors discussed above, a prospective property owner should also consider the following when buying a commercial property:

  • Whether or not the property has any defects, including any defects that were disclosed by the seller, and how those defects will be addressed;
  • A prospective commercial property owner should also hire a professional property inspector to inspect the property for defects that may not be easily noticeable or disclosed by the seller; and
  • A prospective business owner should also determine whether there are any encumbrances on the business that may affect their rights as owner of the property, including any zoning or planning issues.

Should I Consult a Real Estate Attorney About My Commercial Property Issue?

As can be seen, commercial real estate laws can be complex, especially because they vary from state to state. Further, some commercial real estate laws differ from each other within the same county or city. As such, if you are contemplating purchasing a property for commercial use, it is in your best interests to consult an experienced real estate lawyer.

An experienced commercial real estate attorney can help you understand your legal rights and options under your state’s specific laws. Further, an attorney will also be able to represent you in court, as needed, should any legal issues arise associated with the commercial real estate property.

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