If you are about to rent commercial real estate for the first time, you might find the array of different lease types slightly confusing. Here is a simple introduction to the types of leases you might encounter, including their pros and cons.
Gross and Full Service Leases
These are leases in which nearly all property-related costs are combined in a single monthly charge.
- Gross lease: A gross corporate real estate lease contains a number of costs in addition to rent. Your monthly payments will include repairs, insurance and property taxes. Common area maintenance (CAM), which covers the cost of maintaining the property’s shared spaces, may or may not be covered in this type of lease.
- Full service lease: A full service corporate real estate lease is used most commonly when leasing office buildings. The rent includes nearly all costs, including insurance, property tax, maintenance, repairs, cleaning and utilities (perhaps with the exception of electricity costs).
Pros: These lease types are beneficial for tenants because you won’t face many hidden costs, if any, making it easy to forecast the next 12 months’ lease costs. That makes cash management an easier task.
Cons: Tenants will have less control over their costs. If the gross lease doesn’t cover CAM costs, you’ll have to pay these out as an additional expense.
There are three types of net leases commonly in use. They all separate some of the expense payments from the monthly rental payments. You’ll find these commonly used in properties having a single tenant.
- Single net lease: In a single net lease, you will pay a separate charge for the property’s real estate taxes. All other operating costs are the responsibility of the landlord.
- Double net lease: A tenant with a double net lease is responsible for paying property insurance costs in addition to real estate taxes.
- Triple net leases: These leases make the tenant responsible for taxes, insurance and CAM costs, including those for outbuildings and parking lots. This is the most popular type of net lease. Usually, the tenant must also pay its own utility bills.
Pros: Because you are paying some expenses separately, the rent on a net lease property is usually less than had the property been rented with a gross lease. This gives you the possibility of paying less overall by controlling the separate costs. For example, you can save money by keeping maintenance and utility usage to a minimum. You would also benefit in the somewhat unlikely event that property taxes or insurance premiums ever go down.
Cons: You could be on the hook for sudden costly repairs, such as a failure of the HVAC system or a busted water pipe. You also are exposed to costs beyond your control, such as an abrupt property tax hike. This makes net leases somewhat riskier for tenants.
Modified Gross Lease
This type of lease combines elements of a triple-net and full-service lease. The tenant pays for CAM, property insurance and real estate taxes as a fixed lump sum, in addition to the base rent. The landlord usually absorbs the costs of utilities and janitorial services. However, different arrangements are available that more closely mirror single- or double-net leases. Modified gross leases are commonly used in multitenant office buildings, because the tenants don’t have to hassle about the fair distribution of utility bills.
Pros: The costs included in the lump sum are fixed, so they can be planned by the tenant. The more costs excluded from the lump sum, the lower the base rent should be. If CAM costs are included in the lump sum, the tenant doesn’t have to bother with maintenance tasks.
Cons: If you leave maintenance to the landlord, you might not be pleased with the results. Landlords are rewarded for spending the minimum on maintenance with these leases, which could cause your rental property to look shabby and possibly hurt business.
Under a percentage lease, the tenant pays the landlord a base rent plus a percentage of gross sales above a stipulated breakpoint. This type of lease is commonly used for retail stores and restaurants. For example, suppose you and the landlord agree to a breakpoint of $100,000 a month on your restaurant lease. If your gross sales exceed the breakpoint, you pay a fixed percentage, say 4%, of the excess. Thus, if your gross sales were $120,000, the landlord would collect the monthly rent plus 4% of $20,000, or $800.
Pros: The lease helps the tenant when sales are weak, since presumably they would be less than the breakpoint and no extra payments would be due.
Cons: On the other hand, you’ll have to pay more when you have strong sales. However, because it aligns your landlord’s interests with yours, it makes it more likely that the property will be well-maintained.