When it comes to commercial real estate for lease, the lease itself makes all the difference.
A commercial real estate lease—whether it’s for retail space for lease, office space or other commercial buildings—is a major commitment for tenants and landlords alike, involving significant time and capital. That’s why it’s so important to understand the structure of your lease before signing.
In commercial real estate, tenants of commercial buildings typically pay a base rent for using the space plus operational expenses, like maintenance, property taxes, insurance and utilities. The structure of the lease determines who pays these costs directly. With some leases, tenants pay for these operational expenses directly; for example, they pay an energy company variable prices for consuming electricity. With other leases, landlords pay for these expenses directly while incorporating an estimated cost in the tenant’s base pay—usually with an upcharge for assuming risk.
The difference between these lease structures is important. It determines who will pay what, how much risk each party will undertake, and the price of base rent.
There are three main types of commercial real estate leases: Gross, Net and Modified. While there are some variations within these categories, they represent the basic structures of most commercial real estate leases. Let’s take a closer look.
Gross (Full Service) Lease: A Fixed Cost for Tenants, More Control for Landlords
A gross or full-service commercial real estate lease is just what it sounds like. The landlord directly pays for most, or all, operating expenses, including property taxes, maintenance, utilities, insurance, etc. (This usually excludes telephone and data expenses). The landlord incorporates these expenses into the tenant’s rent.
This means that the base rent is relatively high, but it’s the only cost for tenant. Tenants of commercial buildings often prefer this type of lease, as they can depend on paying a fixed, predictable rent payment each month, even if the building’s expenses rise or fall. Also, they don’t have to worry about managing the operations of the building.
While a gross (or full-service) lease makes things simple for tenants, it can also be slightly more expensive. Landlords typically charge a premium for undertaking the risk of paying variable expenses. This also gives landlords more control over the maintenance and appearance of the property.
Net Lease: More Flexibility for Tenants, Less Risk for Landlords
A net lease is a more adjustable form of commercial real-estate lease. With this type of lease, tenants pay some or all operating expenses, like property taxes, insurance and common area maintenance. This means that tenants’ payments vary from month to month, as costs fluctuate. However, the base rent is typically lower.
There are four general categories of Net Leases:
- Single Net Lease: Like a gross lease, the landlord pays most of the building expenses. But now, in addition to their base rent, the tenant pays a piece of the property tax and pays utilities directly.
- Double Net Lease: This is similar to the single net lease. But now, in addition to the property tax, the tenant covers a portion of the property insurance. The landlord still pays for the maintenance of common areas, but the tenant has to cover their own utilities and other services.
- Triple Net Lease: The most common of the net leases, the triple net lease is favorable to landlords, as it requires tenants to pay for their portion of property taxes, insurance and common area maintenance in addition to their base rent. This also has some benefits for tenants: Now that they’re paying operating expenses directly, all the savings on lower costs are passed on to them. (Of course, the risk is passed on, too.)
- Absolute Triple Net Lease: Sometimes, a larger corporation wants to virtually own a single-tenant building without buying it. In that case, an absolute triple net lease allows them to take on all costs of a building and have sole responsibility for its care. This gives the business absolute control over their building; they can build or modify it precisely to their specifications. The downside of this commercial real estate lease is that, if a catastrophic event destroys the property, the tenant may be on their own to absorb the costs.
Modified Gross Lease
Allowing for broader range of negotiations, the modified gross lease is a middle ground between gross and net leases. With this type of lease, tenants and landlords decide how to cover operating expenses, with a base rent that’s subject to the agreed-upon terms. This kind of lease typically binds the landlord to directly pay property taxes, insurance and common area maintenance—rolling these costs into the tenant’s base rent—while the tenant pays directly for utilities, interior maintenance and janitorial services.
If you’re looking at any kind of commercial real estate for lease, including retail space for lease or other commercial real estate, make sure you understand exactly what costs you will be responsible for covering. The lease structure is typically decided by the landlord and based on common local practices; but understanding the three main types of commercial real estate leases can help you negotiate for a better deal.
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