Commercial Lease Types – Apples to Apples

Commercial Lease Types – Apples to Apples

Commercial real estate leases come in many forms and rental rates are represented differently according to how these leases are structured. Some leases require the tenant to pay a portion of operating expenses, while others include all expenses in a single figure, but in a sense, one way or another, the tenant pays for it all but the perception varies.

Every commercial real estate agent seeks to provide the best service to their clients. Therefore, it is important that all understand the ins and outs of the different types of commercial real estate leases.  So, for the commercial agent just starting out, we’ll outline the different commercial leases, identify what expense is paid by whom and the advantages and disadvantages of each.

Usually, when a business leases a commercial space, they enter a multi-year lease, and so the topic of property operating expenses and annual increases of such should be top of mind.  And though the various lease types address these expenses differently, there are almost always provisions protecting Landlords from increases that are beyond their control, so a review of the lease by the tenant and their broker is vital to understanding potential exposure to unforeseen cost increases.

Rate Structures Explained
In describing each type of commercial lease, we will start with the one that requires the least attention to the property on the part of the landlord (Absolute Net Lease) and progress to the type in which all aspects of maintaining and servicing the property fall under the responsibility of the landlord (Full Service).

Absolute Net lease

In this lease, renting the commercial space comes with the responsibility of covering all of the operating expenses and any repairs that are needed, along with monthly “Base rent” which in comparison to the other lease types, should be the smallest amount per square foot ($/SqFt). The tenant is responsible for absolutely every part of the upkeep and repair on the property and the landlord simply collects a check for the Right of the tenant to occupy the premises. Tenants typically remit payment to the local taxing authority, property insurance agencies, utilities and contractors for any alterations, improvements, maintenance or repairs to the property. These are most commonly used in ground leases or single tenant industrial or retail leases where there are no common spaces, grounds or neighboring tenants to manage. In this case the landlord has absolutely no responsibility toward upkeep on the property however the tenant must often return the property in the same or better condition at the end of the lease as it was at its inception.

Triple Net lease

In this lease, the tenant is solely responsible for all the operating costs along with the monthly rent and of course all utilities. In this type of lease the landlord is still responsible for the building structure, walls, roof and the means by which municipalities provide those utilities (electrical panels and plumbing lines), But the tenant is responsible for everything else, often with the tenant’s pro-rata share of Property Taxes, Building Insurance and Common Area Maintenance (CAM) paid as an annual estimated expense divided into monthly installments. At the end of the year the landlord will typically reconcile actual costs against estimated operating expenses collected and bill the tenant for the shortfall or credit them the overage. In the former scenario, the lump sum bill for any shortfall often comes as a surprise to the tenant, creating the false perception that triple net leases favor the landlord.

Double Net lease

In a double net lease, the tenant is responsible for their pro-rata share of Property Taxes and Building Insurance along with the monthly rent and of course all utilities.  The landlord takes care of Common Area Maintenance (CAM) and is of course still responsible for the building structure, walls, roof and the electrical panels and plumbing lines.  A double net lease is sometimes preferred by tenants if there is any question as to the validity of common area expenses, where taxes and insurance are easy to validate.

Single Net lease

A single net lease obligates the tenant to pay for all or their proportionate share of the property taxes along with the monthly rent and of course all utilities.  A tenant might prefer this type of lease if they don't want to be responsible for shopping property insurance policies or negotiating rates for such on the landlords building, or this type of lease might be preferable to a landlord who has an umbrella or portfolio insurance policy on several assets and cannot carve out the annual cost figure for this single property. 

Modified Gross lease

This lease is usually considered as a “win-win” for both parties and why it is the most common lease type in the market across all asset classes with separate utility meters.  This may be perceived as a compromise between net and gross leases.  A modified gross lease makes leasing a commercial space easier on the tenant while the landlord may recover any cost savings.  As stated earlier however, almost every lease has a provision allowing for “Additional Rent” whereby the tenant must pay for any increases in the “Base Rent” (which now includes taxes, insurance and common area maintenance) over a base year, or typically the initial year of the lease term.  What this means is that one way or another, the tenant is paying all expenses.  Any landlord who neglects to include this clause is opening themselves up for reduced margins over the lease term or possible default, as some mortgages will insist on it so that the debt service ratio is protected.

Full-Service (Gross) lease

This is the most common type of commercial real estate lease in multi-tenant office buildings Where utilities are not easily separated or in Class A assets with shared amenities that require a common cost allocation such as contracted building security, concierge, janitorial service, on-site property management, full floor HVAC systems and tenant fitness facilities.   Corporate tenants who are more concerned with employee morale and retention than with cost savings will often seek out Class A buildings and prefer to write one check each month for rent than to worry about the variable cost of utilities and other monthly expenses. Because all of these supplemental costs are lumped together and divided among tenants in a pro rata fashion, there is The perception of cost savings due to the sharing of resources and often less focus on the expense and more focus on the quality of services when it comes to tenant satisfaction.  

Cost Allocation
In order to gauge the allocation of these various costs between landlord and tenant, here is a simple graph as an example to understand how much of each portion of operating expense affects the base rent collected by the landlord.

A commercial real estate lease is a complex legal document with mandatory clauses that vary by state and should be carefully reviewed by the tenant and their broker and if necessary, edited by a qualified commercial real estate attorney.  Most of these documents are designed to protect both the landlord and tenants’ rights, however some leases may be more slanted toward the landlord, depending on their circumstance and experiences.  Every commercial real estate agent who wants to make a name for him or herself should understand at least the very basics of commercial leases to provide superior service to their clients.

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