Franchisee Real Estate Leasing Basics

Leasing the business premises (real estate) can make or break a franchisee, requiring adequate legal oversight thereof.

Contact Neufeld Legal PC for franchising legal matters at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

Many franchise arrangements require that business operations are undertaken from commercially leased real estate, where it is next to impossible to purchase acceptable real estate at which the franchised business is to be undertaken. As such, it is imperative that your commercial leasing arrangements are correctly undertaken and don't financially hurt your business' profitability, with an understanding of the basics of commercial leasing of real estate being important.

Lease: A lease is the legal arrangement between a lessor (landlord) and a lessee (tenant / the franchisee) that gives the lessee the right to use and occupy the real property (leased premises) for a specified period in exchange for regular payments, typically rent, together with outlining the rights and responsibilities of both parties. The lease is formally set out in the Lease Agreement.

Lessor: The Lessor (Landlord) is the owner of the property. The Lessor may be a person or business entity. The Lessor leases the property to the Lessee (Tenant), which would be the franchisee.

Lessee: The Lessee (Tenant) is your role as the franchisee, whether in your personal capacity or via a business entity, whereby you occupy the leased premises and pays rent to the Lessor.

Offer to Lease / Term Sheet: An offer to lease or term sheet is typically a bullet-point list outlining the material terms and conditions of the lease agreement. This will be used during the negotiation stage to determine the base rent, incidental expenses, lease period and other key terms. This document acts as a guide for the lawyers to draft the formal lease agreement.

Lease Agreement: A lease agreement is the formal, written contract that captures all the terms and conditions that enables the Lessee to rent the Lessor's property.

Term: The term of a commercial lease is the duration for which the franchisee (tenant) is granted the right to occupy the leased premises. It is one of the most fundamental and critical elements of any lease agreement, as it dictates the length of the financial commitment for both the landlord and the tenant [more on Term].

Base Rent: The minimum fixed rent paid by the Lessee (the franchisee), often specified on a per-square-foot basis.

Additional Rent: Additional rent refers to charges the Lessee (the franchisee) must pay on top of the base rent, as stipulated in the Lease Agreement.

Gross Lease: A gross lease is a commercial real estate lease where the franchisee (tenant) pays a single, all-inclusive, fixed rental rate. In this arrangement, the landlord is responsible for paying all of the property's operating expenses. This is the most simplified type of lease agreement [more on Gross Lease].

Percentage Lease: A percentage lease is a commercial real estate lease where a franchisee (tenant) pays a base rent plus a percentage of their gross sales. This type of lease is most commonly used in the retail sector, particularly in shopping centers, malls, and other multi-tenant retail properties [more on Percentage Lease].

Single Net Lease: A single net lease is a commercial real estate lease where the franchisee (tenant) is responsible for paying base rent plus one of the major property operating expenses, which is almost always the property taxes. In this arrangement, the landlord is still responsible for the other major operating expenses, such as property insurance and maintenance costs [more on Single Net Lease].

Double Net Lease: A double net lease is a commercial real estate lease where the franchisee (tenant) is responsible for paying base rent plus two of the major property operating expenses, which is almost always the property taxes and the property insurance. In this arrangement, the landlord is still responsible for the other major operating expense, being maintenance costs and structural repairs [more on Double Net Lease].

Triple Net Lease: A triple net lease is a commercial real estate lease where the franchisee (tenant) is responsible for paying a lower base rent plus nearly all of the property's operating expenses (property tax, insurance and maintenance). It is one of the most common and popular lease types for commercial properties because it offers a highly passive investment for the landlord [more on Triple Net Lease].

TMI: TMI in a commercial lease agreement stands for Taxes, Maintenance, and Insurance, and is used to describe the additional costs a franchisee (tenant) is responsible for paying on top of their base rent. The term TMI is most commonly used in leases for single-tenant commercial buildings or in a triple-net (NNN) lease structure [more on TMI].

Common Area Maintenance (CAM): Common Area Maintenance (CAM), also known as operating expenses, is a provision in a commercial lease that requires the franchisee (tenant) to pay a portion of the costs associated with the upkeep and operation of the building's shared spaces. This is a very common term in commercial lease agreements, particularly in triple-net (NNN) leases, where the tenant is responsible for property taxes, insurance, and maintenance costs in addition to their base rent [more on Common Area Maintenance].

Trade Fixtures: A trade fixture is a piece of personal property that a franchisee (tenant) attaches to the leased premises for the specific purpose of conducting their business or trade. While fixtures in general are permanently attached to a property and become part of the real estate, trade fixtures are a key exception. The law recognizes that these items, even if they are physically attached to the building, remain the personal property of the tenant [more on Trade Fixtures].

Leasehold Improvements: A leasehold improvement is a modification or addition made to the interior of a leased space to customize it for a specific tenant's business needs. These improvements are distinct from a landlord's standard building maintenance or repairs. Instead, they are tailored to make the space functional and desirable for a particular tenant [more on Leasehold Improvements].

Tenant Improvement Allowance: A tenant improvement allowance is a negotiated amount of money the landlord agrees to provide to the franchisee (tenant) to help pay for the cost of improving or building out the leased space. This is a crucial financial component of most commercial leases, especially for office, retail, and industrial properties that need to be customized for a tenant's specific use [more on Tenant Improvement Allowance].

Security Deposit: A security deposit in a commercial lease is an amount of money paid by the franchisee (tenant) to the landlord at the beginning of the lease term, which is intended to provide the landlord with financial security against potential future defaults by the franchisee (tenant) [more on Security Deposit].

Sublease: A lease where the original tenant (the sublessor) leases a portion or all of their space to another tenant (the sublessee). The original tenant remains liable for the lease.

Assignment: An assignment in a commercial lease is the transfer of a tenant's entire interest in a lease to a new party, the assignee. The assignee takes over all the original tenant's (the assignor's) rights and obligations under the lease for the remainder of the term [more on Assignment].

Exclusive Use Clause: An exclusive use clause in a commercial lease is a provision that gives a tenant the sole right to operate a specific type of business within a defined area, usually the same shopping center or commercial building. In return, the landlord is prohibited from leasing space to any other tenant that would compete with the franchisee's business [more on Exclusive Use Clause].

Right of First Refusal (ROFR): A right of first refusal (ROFR) is a contractual provision in a commercial lease that gives the franchisee (tenant) the first opportunity to either purchase the property or lease an adjacent space before the landlord can offer it to a third party. This clause is a valuable negotiating tool for a franchisee (tenant), as it provides them with a degree of control over their future in the building [more on Right of First Refusal].

Escalation Clause: An escalation clause in a commercial lease is a provision that allows the landlord to increase the franchisee's (tenant's) rent over the term of the lease. This is a standard feature in most commercial leases, as it allows landlords to keep pace with inflation and rising operating costs [more on Escalation Clause].

Force Majeure: A force majeure clause in a commercial lease is a contractual provision that excuses one or both parties from performing their obligations when an unforeseen event beyond their control makes performance impossible or commercially impracticable. A force majeure clause is designed to address risk and protect parties from liability during catastrophic events like natural disasters, acts of war, government shutdowns, or epidemics [more on Force Majeure].

Holdover: A holdover in a commercial lease occurs when a franchisee (tenant) remains in possession of the leased premises after the lease term has expired without a new lease agreement. This situation is typically addressed by a holdover clause that defines the terms and conditions under which the franchisee (tenant) can remain on the property and the penalties they will face for doing so [more on Holdover].

Christopher Neufeld is a business lawyer knowledgeable in the rigors and challenges of the franchise business, together with the legal constructs that are critical to their effective operation. For experienced legal representation in starting, acquiring / selling, operating and managing a franchise, contact franchisee lawyer Christopher Neufeld at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or Chris@NeufeldLegal.com.

Franchisee Real Estate Leasing Basics - Many franchise arrangements require that business operations are undertaken from commercially leased real estate, where it is next to impossible to purchase acceptable real estate at which the franchised business is to be undertaken. As such, it is imperative that your commercial leasing arrangements are correctly undertaken and don't financially hurt your business' profitability, with an understanding of the basics of commercial leasing of real estate being important. Read more.

 

Franchisee Real Estate Lease: Build and Build-out - Although there are a multiplicity of factors at play when a franchisee is looking to commence their particular franchise operation, two of the more consequential aspects that the franchisee (lessor) needs to be aware of are the build (construction of the building) and the build-out (internal work on the leased premises). Read more.

 

Franchisor as Tenant (with Franchisee subleasing) - Whereas the typical leasing arrangement is for the franchisee to lease the subject property from the property owner (landlord); on occasion, the franchisor will lease the property from the property owner and thereafter proceed to sublease that same property to the franchisee. As opposed to the franchisee leasing directly from the property owner, having the franchisor enter into the lease with the property owner can be advantageous to the franchisee. Read more.

 

Contact us via email at chris@neufeldlegal.com or call 403-400-4092 / 905-616-8864.