Different Types of Commercial Real Estate Leases

Commercial Real Estate Leases

Purchasing a commercial property for an investor can be considered as a great investment option. However, in some cases, either due to capital limitation, buying a property becomes an out rightly not possible making the investors take advantage of the option of leasing a commercial property. Depending on the commercial property type, Commercial Real Estate Leases usually vary from property to property.

Before going further to the lease types, it wise to point out some of the expenses in the leases that a landlord or a tenant will have to cover. The expenses entail janitorial utilities like water, sewer, gas, electricity, communication, interior maintenance costs like air conditioning, heating, plumbing, electricity and carpet cleaning,  and exterior maintenance costs such as landscaping, exterior lighting, and electrical. Other costs may include property insurance, property taxes, roof, plate glass and structural maintenance.

Some lease structures put the expense burden to the landlord side while other structures place the burden to tenant’s side.

Commercial Lease Types

Commercial property leases, in general, are in three main types. The two rent calculation methods that establish these leases are the ‘gross’ and ‘net.’ A gross lease entails tenant paying a lump sum rent amount that the landlord can use to cover the properties expenses. The rent base in a net lease is usually smaller, and therefore the tenant has to cater for the rest of the expenses. When the two types of leases are fused together, they form a modified gross lease.

They lease types in detail are:

  • Full Service or Gross Lease

A gross lease entails an all-inclusive rent. The tenant will pay the full amount of which the landlord will use to settle the expenses for the property services like insurance taxes and maintenance.  The tenant payment is friendly enough to encompass additional services like security, utilities and janitorial.

The janitorial services that the property provides and the number of times offered are made clear during the negotiation process of the gross lease. There is also clarification on the excess utility consumption that somehow exceeds the building standards. For instance, if a tenant has a huge electricity consumption, it should be made clear in the lease agreement. In such situations, some expenses like taxes and insurance attached to the property will be covered by the tenant.

The easiness with which a tenant can forecast expenses without worrying unexpected charges is one of the beneficial things that a tenant gains in such a lease type. The tenant will have plenty of time to concentrate on the business growth as the focuses on building responsibilities.

  • Net Lease

In this kind of lease, the landlord charges the tenant base rent for the commercial rent plus some operating and maintenance expenses attached to the property. These may entail property insurance, real estate taxes. It also may include some common area maintenance items like parking lots, trash collection, fire sprinklers, sewer, water, property management fees, janitorial services, and any commonly shared service.

Net leases are subdivided into several types as follows:

Single Net Lease (N Lease)

It is a lease whereby a tenant will pay the expected base rent together with some building property expenses such as property tax on a pro-rata share basis as the bill will be apportioned regarding the total building space that the tenant will lease. Even as the tenant settles janitorial services and utilities, the landlord will have to cater for other building expenses.

Double Net Lease (NN Lease)

In addition to the rent payment to the landlord, the tenant will settle the property insurance and property taxes on also a pro-rata basis. The landlord caters for common area maintenance expenses and structural repairs as the tenant deals with utility and janitorial expenses that are incurred.

Triple Net Lease (NNN Lease)

The net-net-net (NNN) lease is the most popular net lease type for retail space and commercial freestanding buildings. In this lease the tenant has an obligation to the basic monthly rent together with pay all or a part of the “Nets’, which is insurance, property taxes, and common area management expenses (CAMS). Other Operating expenses and common area utilities like lobby attendant staffing cost are accounted as part of NNN fees. As usual, tenants have to cater for their taxes, insurance, utilities and janitorial services related to the property occupancy.

A pro-rata or proportionate share is used to estimate the charges and expenses that landlord levy on tenants. For instance, when a tenant leases 2000 square feet of a property that have 20000 square feet of property space, only 10% of the building’s insurance, CAMS, and taxes.

Tenants ought to carefully negotiate caps and review NNN fees regarding the annual amounts since triple net leases tend to lean on the side of the landlord. Forecasting a business’ expenses can be at times frustrating and tricky since NNN lease may fluctuate, decrease or increase, from period to period, either monthly or yearly.

However, NNN leases also bestow the tenant with benefits. There is transparency enhanced as a tenant can vividly connect what is charged to the business operating expenses. As such, the tenant enjoys some cost savings rather than the property’s landlord. Overall, tenants are levied a higher responsibility to cater for the building since NNN lease monthly rent is lower than for a gross lease.

Absolute Triple Net Lease

It is more binding and rigid than an NNN lease making it a less commonly utilized option. Tenants are left to carry the burden of every risk in the real estate that is imaginable. For instance, the tenant may be called upon to pay rent for a condemned building or cater for reconstruction expenses after a catastrophe. In essence, as a high-water lease, it puts the ultimate responsibility of catering for the building to the tenants.

  • Modified Gross Lease

In a scenario where there is a net lease which is more landlord-friendly and a gross lease that is more tenant-friendly, a modified gross lease comes in as a convenient compromise. In a modified gross lease or modified net lease resembles a gross lease as it requests rent in a lump sum which may account for all or some of the nets’ like property insurance, taxes, and CAMS. It excludes janitorial services and utilities from rent that the tenant will need to cover. The ‘nets’ that the base rental rate will include are negotiated upon with the landlords and tenants.

Modified gross lease allows for an easier landlord and tenant agreement since it is much more flexible making tenants use it popularly. It permits for the building’s operating expenses to be shared using a pro-rata share that is based on the percentage of the occupied building. For example, s tenant will cover 50% of operating costs when the tenant’s business occupies 50% of the building.

Unlike the scenario seen in NNN lease, the lease rate will remain constant even if taxes, CAM or insurance charges increase. However, the landlord stands to benefit from cost savings when such expenses decrease. Since it does not cover electricity and janitorial service, tenants are more able to plan and control the property expenses in comparison to a gross lease.

What to grasp in the Commercial Lease types

When analyzing the different lease options, it is critical to not only focus on the base rental rates but also examine all expenses when determining the office space lease options. Though there are some additional expenses added to the monthly rate, NNN base rental rates are usually lower.

Regardless of the lease type, the market forces will act to stabilize the rental rates of various properties. As such for office spaces that are similar and located in the same area, roughly the same amount of full service, modified gross or NNN lease will be charged to the tenant.

What is crucial when it comes to commercial leases is for tenants to carefully clarify what expenses they ought to cater for in the respective leases. Cases, where additional charges may emerge, ought to be fully discussed and negotiated.