Commercial Leases: Which Kind Is Right For Your Deal?
Let’s take a quick look at the four most common types of commercial leases: gross, modified gross, triple net, and bond lease. Which one is right for the deal you’re trying to complete?
Common especially for office buildings, in a gross lease, expenses in the operating category such as trash collection, janitorial, utilities, landscaping or management fees are typically picked up by the landlord. While operating expenses under a gross lease are often picked up by the landlord, beware of terms such as an expense stop, aka a limit imposed on the amount of such expenses paid by the landlord and that sends any costs over that stop to the tenant. This “stop” can be calculated in a variety of ways, but often you’ll see terms that use the historical expense profile of the property in previous years (sometimes called “base year”) used as the amount that the landlord will be paying — and no more than that.
Modified Gross Lease
Often this type zeroes in on utilities and janitorial expenses and passes them to the tenant. This type of lease is often used for businesses with extreme needs for electrical power or for tenant operations that require direct control and/or exclusive use of HVAC, and so tenants will accept the maintenance costs for HVAC. Expense categories are by no means boilerplate, meaning what constitutes tenant costs vs what constitutes landlord costs are subject to negotiation. Concepts like CAM (common area maintenance) charges are fungible: they might be broken out into sub-categories for the purpose of isolating costs so that they can be assigned to specific tenants.
Triple Net Lease
In gross leases, the tenant pays its share of operating expenses usually calculated by a “base year” calculation, with payment limited to certain operating costs. The triple net is where the tenant is on the hook for 100% of operating expense of the tenant’s share of the space. Costs commonly include the big three (aka the “triple” in “triple net”): property taxes, insurance and common area maintenance (CAM). Commonly used in retail centers, the triple net lease can result in lower rent payments but with operating expense charges added in, comparisons to gross leases on comparable properties can result in similar total payments. Sometimes called the “hell or high water” lease, the triple net still usually doesn’t send 100% of building costs toward the tenant: very commonly, the responsibility for rooftop maintenance and the structural integrity of the building are the responsibility of the landlord.
The most unusual of the four lease types, bond leases go further than triple net in assigning costs to tenants. The responsibility for maintenance and replacement if necessary, of building systems, roofing, exterior and structural components of the building can be assigned to the tenant under a bond lease, in addition to the obligations under a triple net lease. Even further, a bond lease can assign to tenant capital expenses and tenant improvement costs. Under a bond lease, if the building falls down, the tenant is likely on the hook for rebuilding it. Bond leases are typically used for single-tenant properties and situations where financialization of the lease is a priority — the tenant being responsible for nearly everything associated with the property’s operation and continued existence means the lessor’s position is about as liquid as it gets in commercial real estate.
(Reference: SIOR Glossary of Real Estate Terms)
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