Types of Commercial Real Estate Leases
If you’re just plunging into the world of commercial real estate leases, you might feel a little overwhelmed by the different terms used in the field. You might even feel unsure of what you’re getting into. But those terms aren’t as intimidating as many people think.
All leases are based around two main calculation methods – gross and net. Within each method, there are a variety of types: full service lease, which is also referred to as full service gross, modified gross, and a variety of net lease, including triple net. These leases provide a base from which rent and expenses are calculated. In both cases, the tenant pays a base rent for the property and the type of lease will determine whether the tenant or landlord pays the other operating expenses.
For instance, in a gross lease, the tenant is expected to pay a monthly lump sum rent that includes utilities, taxes, maintenance fees, janitorial fees, security fees, etc. The landlord includes all these fees in the rent and then pays for these expenses on behalf of the tenant.
For a net lease, the fundamental principle is that the landlord charges only the base rent, and the tenant contracts and directly pays for any other operating expenses including property taxes, insurance, janitorial services, maintenance fees, security fees, water, trash fees and other costs.
So, without further ado, let’s discuss the three types of commercial leases in more detail.
1. Gross Lease
Full Service or Full Service Gross Lease:
In a full service lease, the tenant is charged a monthly rental fee that covers all operating expenses. These expenses usually include property taxes, maintenance fees, utilities, etc. The landlord then pays for these expenses using the rent paid by the tenant. For this reason, the base rent charged to the tenant is usually high, but it’s the only cost the tenant has to pay.
Those tenants who do not like to be involved in the everyday expenses of the building prefer this type of lease. The main advantage with this lease is that the rent remains fixed, even if the expenses change. For instance, during summer, when electricity costs increase because of air conditioning, the rent remains the same. This lease is common in multi-tenant industrial or office buildings and retail shopping centers.
However, this lease also comes with a few nuances. Most landlords like to include a provision allowing them to pass through certain increases in operating expenses. As such, a tenant can expect that the monthly amount paid to the landlord could increase over the term of the lease based on expenses they can not directly control.
Modified Gross Lease:
The last type of commercial lease is the modified net lease, sometimes called the modified gross lease. This commercial lease is a marriage of the two primary leases – gross and net – and offers a comfortable midpoint for both the tenant and the landlord.
The lease allows a whole lot of negotiation when it comes to who pays for which expenses. The rent will also be extensively negotiated and agreed upon by the two parties.
2. Net Lease
The net lease is one of the most flexible commercial leases in real estate and is common for single tenant buildings. In a net lease, the amount paid to the landlord will be less than a gross lease, as the tenant is responsible for paying operating costs including insurance, property taxes and common area maintenance (CAM) items.
There are four categories of net leases:
- Single Net Lease: The tenant is responsible for paying property taxes in addition to rent. The landlord pays for insurance and maintenance associated to the building. In most cases, the tenant is responsible for paying for utilities as well as garbage and janitorial services.
- Double Net Lease: A double net lease is similar to a single net lease, but in this case the tenant pays for property insurance in addition to rent and property taxes.
- Triple Net Lease: The triple net lease is one of the most common lease types in the commercial real estate market today. The tenant is responsible for paying rent, property taxes, insurance, and any maintenance costs. As a result, triple net leases are a favorite of landlords.
- Absolute Triple Net Lease: With the absolute triple net lease, the tenant pays all the costs, giving them full responsibility for the building. The responsibility on the tenant is similar to buying the building altogether. The advantage of this lease is that the tenant virtually owns the building without purchasing it. However, if catastrophe strikes and the whole building is destroyed, the responsibility solely lies on the tenant.
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