Browse Tag: leases

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?

Gross Lease

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.

Bond Lease

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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The Stalled Escalator: Rigged LIBOR And Rent Increases

Under Repair

Brokers and landlord reps use of the escalation clause in a commercial space lease is a common one. These clauses provide for increases in rent over a specified period of time. Often, these increases are determined not by actual increases in the landlord’s operating costs, but are instead keyed to an index, such as the consumer price index (CPI) or the London Interbank Offered Rate (LIBOR).

Longer-term office leases so often involve the landlord’s lender that negotiations over lease provisions can seem to be between a tenant and lender rather than tenant and landlord. When a lender is in a position of underwriting the cash flow of a building, it’s that lender’s job to scrutinize closely the creditworthiness of a prospective tenant.

And therein lies the rub these days. The capacity of lenders to scrutinize creditworthiness has been called into very stark question thanks to a continuing series of scandals and financial meltdowns, the latest of which probably directly affects the lease on your table today. The LIBOR number — an interest rate that drives the rent escalation clause math in untold numbers of commercial space leases — looks like it is, was, and continues to be, in a word, rigged by banks. Banks, under investigation for engaging in book-cooking to cover their derivatives traders and to pretend to the wider market that the cost of money is lower than they actually pay, have distorted the LIBOR number to the point that holders of financial transactions that are keyed to it are hurriedly reviewing their portfolios in a hunt for lost money. And there’s plenty to find — LIBOR lives in the beating hearts of $350 trillion worth of contracts according to the Financial Times.

Going Up? No, actually

One argument about LIBOR in commercial space leases is that the bank scandals benefited tenants at the direct expense of landlords using escalation clauses tied to LIBOR. If, as allegations claim, starting in 2007, large banks began underreporting their costs of borrowing in order to stave off a rising sense of panic in the credit markets, that means that during those quarters, commercial landlords using LIBOR indexing in their escalation clauses were left holding the bag on rent — charging tenants less than they would have been due under the lease terms had LIBOR not been corrupted for the purposes of the banks’ charade.

One of the truisms in this business for both prospective tenants and landlords is to protect yourself — to secure your own representation at the deal table or otherwise run the risk of having your interests overlooked. But when our pinstriped friends the bankers are at the same table, offering both sides index numbers that amount to broken instruments designed to cover some derivative trader’s rear end instead of either the tenant or the landlord’s — how do you protect from that?

(Photo credit: Jeremy Brooks)

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