How to Master Commercial Lease Evaluation

When it comes to commercial, investment, and restaurant properties, few documents are as critical as the lease agreement. This legal contract dictates the relationship between landlord and tenant, outlining everything from financial obligations to operational restrictions. A thorough evaluation of a lease agreement before signing can mean the difference between a profitable venture and a costly mistake.

Understanding the Fundamentals of Commercial Lease Agreements

Commercial lease agreements are significantly more complex than residential leases. Unlike residential leases that typically follow standardized formats, commercial leases are highly negotiable and vary widely in their terms and conditions. This flexibility can work to your advantage if you know what to look for and how to negotiate effectively.

In the hospitality and restaurant industries, lease agreements take on even greater importance. Restaurants often require specialized infrastructure, specific zoning permissions, and expensive build-outs that make the terms of the lease critical to the business’s success.

Types of Commercial Leases

Before diving into the evaluation process, it’s essential to understand the different types of commercial leases you might encounter. Each type allocates costs differently between landlord and tenant.

• Gross Lease: The tenant pays a flat rental amount while the landlord covers most operating expenses like property taxes, insurance, and maintenance.
• Net Lease: The tenant pays base rent plus some portion of operating expenses. These are further categorized as single net (N), double net (NN), or triple net (NNN) leases depending on which expenses the tenant assumes.
• Modified Gross Lease: A hybrid approach where the tenant and landlord share operating expenses.
• Percentage Lease: Common in retail and restaurant spaces, this includes base rent plus a percentage of gross sales, typically above a specified threshold.

Understanding which type of lease you’re reviewing is the first step in proper evaluation. For restaurants and retail establishments, percentage leases require careful analysis of sales projections to determine potential total costs. For more details on the different lease types, check out our guide on demystifying restaurant lease types.

Key Elements to Evaluate in a Lease Agreement

When reviewing a commercial lease, pay careful attention to these critical components:

Rent Structure and Escalations

The rent is obviously a primary concern, but don’t just focus on the starting rate. Understand how the rent will change over time:

• What is the base rent, and what does it include or exclude?
• How frequently will rent increase, and by what percentage or formula?
• Is there a cap on annual increases?
• For percentage leases, what is the sales threshold before the percentage kicks in?
• Are there any rent abatements or free rent periods during the initial buildout?

A lease with a lower starting rent but aggressive escalations might end up costing more than one with a higher initial rate but modest increases. Project the total cost over the entire lease term to make a fair comparison.

Term Length and Renewal Options

The lease term is a balancing act between security and flexibility:

• Is the initial term appropriate for your business plan and investment recovery?
• What renewal options are available, and how is the rent determined for renewal periods?
• Is there a right of first refusal for adjacent spaces if you need to expand?
• Are there early termination provisions or buyout options if your business needs change?

For restaurants, longer terms (5-10 years) are often necessary to justify the substantial upfront investment in kitchen equipment and specialized buildouts. However, ensure you have renewal options at reasonable rates to protect against substantial rent increases after your initial term.

Operating Expenses and CAM Charges

Common Area Maintenance (CAM) charges and other operating expenses can significantly impact your total occupancy cost:

• Which operating expenses will you be responsible for beyond base rent?
• How are CAM charges calculated and allocated among tenants?
• Is there a cap on CAM increases year over year?
• Do you have the right to audit CAM charges?
• Are capital improvements included in operating expenses passed through to tenants?

We’ve seen cases where operating expenses end up adding 30-50% to the base rent, dramatically affecting a tenant’s bottom line. Request historical operating expense data to understand typical costs and identify any unusual spikes.

Use Clauses and Exclusivity

Particularly important for restaurant and retail businesses:

• Does the use clause adequately describe all aspects of your business operations?
• Are there any prohibited uses that might restrict future business evolution?
• For restaurants: Are there restrictions on hours of operation, alcohol service, odors, or noise?
• Do you have an exclusivity clause preventing the landlord from leasing to competitors?

The use clause defines what activities are permitted in your space. A narrowly defined use clause may limit your ability to adapt your business model over time. Conversely, an exclusivity clause can protect you from direct competition within the same property, which is particularly valuable for restaurants and specialty retailers.

Financial Analysis and Risk Assessment

Beyond the obvious lease terms, a proper evaluation requires financial analysis to understand the true cost and risk associated with the lease obligation.

Total Occupancy Cost Calculation

To accurately compare different lease options, calculate the total occupancy cost:

• Base rent + estimated operating expenses + percentage rent (if applicable)
• Utility costs (if not included in operating expenses)
• Maintenance and repair costs you’ll be responsible for
• Property and liability insurance requirements
• Initial tenant improvement costs amortized over the lease term

Express this as both a total monthly/annual figure and as a percentage of projected revenues to ensure the location remains financially viable. For restaurants, occupancy costs typically should not exceed 6-10% of gross revenues, though this varies by concept and location.

Evaluation of Financial Terms

Assess the financial implications of various lease provisions:

• What is the security deposit requirement, and under what conditions will it be returned?
• Are personal guarantees required, and can they be limited in scope or duration?
• What financial penalties exist for late payment or default?
• Are there tenant improvement allowances, and what are the conditions for receiving them?

Personal guarantees are particularly important to evaluate, as they can extend your liability beyond the business entity to your personal assets. Negotiate for a “good guy guarantee” that limits personal liability if you surrender the premises in good condition, or a guarantee that burns off after a period of timely payments.

ROI Analysis for Restaurant and Retail Spaces

For restaurant and retail tenants, calculate whether the projected revenue from the location will justify the lease costs:

• Project monthly sales based on location, foot traffic, and demographic analysis
• Calculate the break-even point including all occupancy costs
• Compare expected revenue to industry benchmarks for similar concepts
• Determine how long it will take to recoup your initial investment

This analysis is critical for restaurants, where location dramatically impacts success and buildout costs are substantial. A prime location with higher rent may offer better return on investment than a cheaper space with less foot traffic or visibility.

Legal Protections and Contingency Planning

A thorough lease evaluation must consider worst-case scenarios and include protections against them.

Assignment and Subletting Rights

Your ability to transfer the lease is crucial for exit planning:

• Can you assign the lease or sublet the space with landlord approval?
• What conditions must be met for the landlord to approve an assignment or sublease?
• Can the landlord recapture the space if you request to assign or sublet?
• Do you retain any profit from subleasing at a higher rate?

Restaurant operators should pay special attention to assignment provisions, as the ability to transfer the lease along with the business can significantly impact the value of your operation when it’s time to sell.

Default and Remedy Provisions

Understand what constitutes default and the consequences:

• What events trigger a default under the lease?
• Is there a cure period for different types of default?
• What remedies does the landlord have in case of default?
• Are there acceleration clauses that make all future rent due upon default?

Look for provisions that allow reasonable time to cure defaults before the landlord can exercise remedies. For non-monetary defaults, such as maintenance issues, you’ll want a longer cure period than for failure to pay rent.

Force Majeure and Business Interruption

The COVID-19 pandemic highlighted the importance of these provisions:

• Does the lease include force majeure provisions for events outside your control?
• Do these provisions excuse or merely delay rental obligations?
• Is there rent abatement if the space becomes unusable due to damage or government orders?
• What insurance coverage does the landlord maintain for the building?

Modern leases should address pandemic situations, government-mandated closures, and other business interruptions that were often overlooked in pre-2020 agreements. Our experience has shown that tenants with well-drafted force majeure clauses were better positioned to negotiate rent relief during mandatory closures.

Physical Space and Operational Considerations

The physical attributes of the space and operational allowances in the lease are particularly important for restaurant and retail tenants.

Space Definition and Measurement

Verify the actual space you’re leasing:

• How is the square footage calculated (rentable vs. usable space)?
• Is there a provision for remeasurement, and who bears that cost?
• What common areas are included in your rentable square footage?
• Are the premises’ boundaries clearly defined in the lease?

It’s not uncommon for the actual usable space to be 15-20% less than the rentable square footage due to common area factors. For restaurants, ensure the lease clearly defines outdoor seating areas, storage spaces, and any shared facilities.

Maintenance and Repairs

Understanding maintenance responsibilities is critical:

• Which systems are your responsibility to maintain (HVAC, plumbing, electrical)?
• Is there a clear distinction between maintenance, repairs, and replacements?
• Who is responsible for structural elements, roof, and building envelope?
• Are there specific maintenance standards or schedules you must follow?

Restaurant tenants should pay special attention to kitchen-specific systems like exhaust hoods, grease traps, and specialized plumbing, as these can be costly to maintain and repair. Negotiate for the landlord to be responsible for replacing major systems that have reached the end of their useful life.

For more insights on navigating restaurant-specific lease terms, see our comprehensive guide to leasing a restaurant in Toronto.

Signage and Visibility

For retail and restaurant businesses, visibility is essential:

• What exterior signage rights do you have?
• Are there restrictions on sign size, design, or illumination?
• Do you have the right to window displays and temporary promotional signage?
• Will the landlord’s construction activities ever obstruct your visibility or signage?

The lease should clearly define your signage rights and protect against landlord activities that might diminish your visibility, such as installing kiosks or landscaping that block sightlines to your space.

Navigating Lease Negotiations

Once you’ve evaluated the lease agreement and identified concerns, effective negotiation is key to securing favorable terms.

Prioritizing Negotiation Points

Not all lease provisions are equally negotiable or important:

• Identify your “must-have” provisions versus “nice-to-have” items
• Understand which issues are deal-breakers for your specific business model
• Research market conditions to know which provisions landlords are typically flexible on
• Prepare alternative language for problematic clauses

In strong landlord markets, focus on negotiating the provisions that most directly impact your business operations and financial risk. In tenant-favorable markets, you can push for more concessions across the board.

Working with Professional Advisors

Commercial leases are complex legal documents that benefit from professional review:

• Engage a real estate attorney with experience in your industry
• Consult with a commercial real estate broker who understands current market conditions
• Consider having your accountant review financial terms and tax implications
• For restaurants, involve your architect early to identify any design limitations

The cost of professional advisors is minimal compared to the potential financial impact of unfavorable lease terms over a 5-10 year period. Be wary of common pitfalls in commercial leases that experienced professionals can help you avoid.

Documenting Verbal Agreements and Understandings

Ensure all agreements are properly documented:

• Get all landlord promises in writing as part of the lease or as exhibits
• Clearly define any tenant improvement work the landlord will perform
• Document any verbal assurances about exclusivity, future development, or building improvements
• Use photographs or detailed descriptions of the condition of the premises at lease signing

We’ve seen numerous disputes arise from verbal assurances that weren’t incorporated into the final lease document. Remember: if it’s important to your business, it needs to be in writing.

Special Considerations for Restaurant Leases

Restaurant leases have unique considerations that deserve special attention during evaluation.

Zoning and Permitting

Confirm the space is properly zoned and permitted for restaurant use:

• Is the space zoned for your specific type of restaurant operation?
• Are there any alcohol service restrictions in the area?
• Does the space have the necessary grease interceptors and ventilation systems?
• Are there noise ordinances that might restrict your hours of operation?

Make your lease contingent on obtaining all necessary permits and licenses. We’ve seen restaurateurs invest significant capital in spaces only to discover they can’t obtain liquor licenses or install proper ventilation systems.

Co-Tenancy and Exclusivity

The tenant mix and exclusivity protections are crucial for restaurants:

• Are there co-tenancy provisions that provide rent relief if key anchor tenants leave?
• Do you have exclusivity for your concept or menu items?
• Are there restaurant density restrictions in the property?
• How will competitor restaurants be positioned relative to your space?

In multi-tenant properties, the success of your restaurant can be significantly impacted by the overall tenant mix and the placement of complementary and competing concepts.

Build-Out and Design Flexibility

Restaurant spaces require substantial customization:

• Does the lease provide adequate time for design, permitting, and construction?
• What approval rights does the landlord have over your design and construction?
• Are there any design standards or criteria you must adhere to?
• Can you make future alterations to adapt to changing business needs?

Negotiate for tenant improvement allowances that reflect the specialized infrastructure required for restaurants. Consider including a provision that lets you take certain trade fixtures and equipment when you vacate, particularly for custom items with significant value.

For in-depth guidance on restaurant-specific lease issues, we recommend reviewing the benefits of using a realtor to decipher your restaurant lease.

Final Evaluation Checklist

Before signing any commercial lease, run through this comprehensive checklist:

1. Financial Terms: Verify all rent amounts, escalations, operating expenses, and additional costs.
2. Term and Options: Confirm the initial term, renewal options, and rent calculation for option periods.
3. Use and Exclusivity: Ensure permitted uses align with your business plan and exclusivity provisions protect against direct competition.
4. Maintenance and Repairs: Clearly understand all maintenance and repair obligations and associated costs.
5. Alterations and Improvements: Verify approval processes for initial build-out and future modifications.
6. Assignment and Subletting: Confirm your rights to transfer the lease or sublet space.
7. Default and Remedies: Understand what constitutes default and the consequences.
8. Insurance Requirements: Review all required insurance coverage types and limits.
9. Security Deposit and Guarantees: Verify the amount, terms for return, and extent of any personal guarantees.
10. Compliance with Laws: Ensure the space can legally accommodate your intended use.

Conclusion

A thorough evaluation of a lease agreement is essential for protecting your business interests and ensuring the viability of your operation. Take the time to understand every provision, calculate the true occupancy cost, and negotiate terms that support your business objectives. The initial investment in careful lease review and professional guidance will pay dividends throughout the lease term by avoiding costly disputes and unfavorable terms.

Remember that lease agreements, particularly for restaurants and specialized commercial spaces, are highly negotiable documents. Landlords expect some back-and-forth on key provisions. With proper preparation and understanding of the market, you can secure terms that set your business up for success.

At CHI Real Estate Group, we specialize in helping clients navigate the complexities of commercial, hospitality, and investment property leases. Our experience with restaurant and retail tenants gives us unique insight into the specific needs of these businesses. We’re committed to empowering our clients to make well-informed decisions and negotiate excellent terms.

We understand that evaluating a lease agreement can be daunting, but with the right approach and expertise, it becomes a manageable process that protects your business interests and contributes to your long-term success.

Ori Grad

Ori is a licensed Broker and Certified Negotiation Expert with deep roots in Toronto’s restaurant scene. Starting his career in kitchens as a cook, dishwasher, and pizzaiolo, he later transitioned into commercial real estate, where he’s become known for his insider knowledge of food and beverage spaces. With a decades-long track record and clients ranging from Bar Raval to DaiLo, Ori combines personal experience as a landlord with a practical, approachable style that helps both seasoned operators and first-time buyers navigate leases, licensing, and location.