Commercial real estate leases can seem daunting, especially since they’re a long-term commitment that can cost a lot of money.
But, they’re not as complicated as many think. There are three categories of leases when it comes to commercial real estate: Gross Lease (also known as Full Service Lease), Net Lease, and Modified Gross Lease. The main similarity among these leases is that they all provide a base rent with variations around who pays for which operational expense.
Here’s a breakdown of the different types of leases, and what they mean for both tenants and landlords:
Gross Lease/Full Service Lease
In a gross lease, the tenant’s rent covers all property operating expenses. These expenses can include, but aren’t limited to, property taxes, utilities, maintenance, etc. The landlord pays these expenses using the tenant’s rent to offset the costs. As a result, the base rent is typically relatively high, but is the only cost to the tenant.
Tenants tend to prefer this type of lease because they don’t have to get involved in the day-to-day operations of the building the rent is fixed, even if the expenses aren’t. For example: during the summer, rent will remain the same even though air-conditioning use increases electricity costs. This lease is typical for industrial, retail and office freestanding properties.
Many landlords try and include some variable cost flexibility in the lease by adding “escalation clauses” that account for an increase of insurance or taxes. They can also include language that allows them to temporarily increase your rent based on variable costs. Using the same air-conditioning example, you would receive an increase in your next month’s rent or a bill to cover the cost of use from the previous month.
The net lease is a highly adjustable commercial real estate lease. The base rent for a net lease is lower than a gross lease, but the tenant also pays fixed operating expenses such as property taxes, insurance, and common area maintenance (CAM) items. There are four types of net leases:
Single Net lease: In a single net lease, tenants pay a set rent and a piece of the property tax (which would be negotiated with the landlord). The landlord then pays building expenses, while the tenant pays utilities and other services directly.
Double Net Lease: A double net lease is similar to the single net lease, except the tenant also pays a piece of the property insurance along with the property tax. The landlord takes over paying for maintenance of the common area, but the tenant is still responsible for his or her own utilities and garbage services.
Triple Net Lease: The triple net lease encompasses property taxes, insurance, and common area maintenance, with the tenant paying for some or all of the cost of these three things on top of their base rent. It is one of the most common lease types. This lease structure is definitely favorable to landlords, but that doesn’t mean it’s benefits for the tenant. The lease does give tenants the ability to review the landlord’s operating expenses, and all savings go directly back to the tenant.
Absolute Triple Net Lease: This is the triple net lease magnified. The tenant takes on all costs enabling them to have sole responsibility of the building. It might just be better to purchase a freestanding building out right. The benefit in this lease is that as the tenant you can virtually own a building without buying it; however, if there is a catastrophe that destroys the property you are on your own. This is probably the most uncommon commercial real estate lease.
Modified Gross Lease/Modified Net Lease
The third major type of commercial real estate lease is the modified gross lease (or modified net lease) and offers a happy middle ground for both tenants and landlords. The modified gross allows a broader range of negotiations when it comes to operating expenses. The base rent will then be subjected to the terms agreed upon by both parties like the gross lease. The differentiating factor is that the lease rate remains fixed even if costs increase or decrease.
Credits: HighTower Blog