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.
Over the past 5 years, RealtyZapp has been helping brokers
become more pro-active in their marketing, streamlining their process while improving engagement and follow up to help commercial property owners accomplish their goals of leasing or selling assets faster.