As a commercial landlord, your understanding of the pros and cons of different types of commercial leases will be critical to signing and retaining good tenants. A commercial lease is a binding contract between you, as the owner or landlord, and a tenant.
The lease details all of the rights and responsibilities of each party. The commercial lease covers both the leased space and the building as a whole. Not every lease agreement is the same. Each agreement you draft should reflect the individual needs and concerns of both you and your tenant. To help you understand the distinctions, here’s a rundown of the main types of commercial leases and the pros & cons for each.
Note: This article covers lease types used in the United States.
A gross lease, also known as a full-service lease, is an agreement where the tenant pays a monthly fixed rent. The landlord is responsible for all of the operational and maintenance expenses, which typically include property management, insurance, utilities, and taxes. Consider a full-service gross lease as something similar to an all-inclusive vacation package: one fee pays for your stay and includes all of the amenities.
Pros of a gross / full-service lease
This type of lease benefits a tenant because it guarantees there will be no surprise expenses, and they can budget accordingly. All the tenants need to worry about is the base rent. Tenants appreciate a gross lease because it allows them to focus on running their business without any additional concerns about the state of the building. As a landlord, you can often charge a higher per-square-foot rate because the rent includes everything.
Cons of a gross / full-service lease
This lease type involves more hands-on attention for the landlord, who is fully responsible for maintaining the physical condition of the building and all of its systems. This is not an ideal scenario for the commercial property owner looking for a passive investment unless they are willing to hire a property manager. Some tenants may not like a gross lease because they have little say in the building’s general appearance and no control over when maintenance is completed. They may also be sensitive to a higher rent than with other types of commercial leases.
“From a landlord’s perspective, gross/full-service leases are usually only offered in buildings where electric and/or water are not separately metered.
To separate these per space in the building can be a significant expense to the landlord. The landlord has the potential of increasing his margins if they are able to successfully lower energy consumption (i.e. installing LED lighting or water conservation equipment such as pressure pumps, etc).
The disadvantage for the landlord is a much higher operating expense, and more difficulty competing given the perception of a higher lease rate since many tenants underestimate the true cost of the various items baked into the gross figures.”
A modified gross lease or modified net lease agreement varies slightly from a full-service gross lease because it specifies more involvement on the part of the tenant. The tenant pays base rent at the start of the lease but takes on a proportional share of some of the other operating costs of the property. The landlord covers the maintenance and operation costs for the common areas of the building (also referred to as common area maintenance or CAM) along with taxes and insurance.
Pros of a modified gross / modified net lease
This lease type requires less work on the part of the landlord as their responsibility is only for the common areas like keeping entryways and hallways clean and vacuumed, walks shoveled, and parking lots cleared. Landlords and owners save money in this lease structure as they no longer pay for janitorial services and utilities inside the rented units.
Cons a modified gross / modified net lease
Because the tenant has more financial and physical responsibility with this type of lease.,landlords lose some control over how and when repairs within a unit get completed.
What is a triple net lease?
A triple net lease is the most popular of all the commercial lease types, and with good reason, it offers significant benefits to landlords and owners. In a triple net lease, the landlord distributes all of the costs for common area maintenance, property taxes, and property insurance across tenants on a pro-rata basis. This type of lease is the opposite of a gross or full-service lease. There are also two other types of net leases:
Single net lease
With a single net lease agreement, the tenant is responsible for their rent and the property taxes associated with the space. The landlord pays all other operating expenses.
Double net lease
With a double net lease, the tenant is responsible for rent and a portion of two of the significant operating cost categories; this is usually property taxes and insurance. The landlord/owner covers all maintenance and repairs. This is the most common lease type in a multi-tenant building. For example, if a tenant rents 10% of the building, they’re obligated to pay 10% of the insurance and property taxes.
Pros of a triple net lease
The triple net commercial lease is very landlord/investor-friendly; it delivers passive income and poses very little in the way of day-to-day management demands. Tenants also benefit from the triple net lease because they can change the building or unit as they see fit. The base rent is often lower because the tenants pay all of the building’s expenses.
Cons of a triple net lease
Landlords/owners give up a lot of control of the building with a triple net lease. If a repair is necessary for a unit, it’s the tenant’s responsibility to hire a contractor and pay for the work. The landlord does not necessarily know when the work gets completed and whether it meets the desired standard.
“Triple net leases are more difficult to negotiate. They imply that the tenant pays its share of the property operating expenses, but tenants will often try to negotiate expense caps or exclusions. On the plus side, the landlord is protected on most operating expense increases because the tenant will pay mostly all the increases.”
In a percentage lease, the tenant pays a percentage of their gross revenue, in addition to their base rent and other expenses. Owners of retail store space, malls, shopping centers, and restaurant space typically use this type of lease agreement, as well as property owners who rent to a start-up entity. The base rent is often low, but the landlord makes up the gap with the percentage the tenant pays on sales. The typical percentage is 7%, but this rate is negotiable and can fluctuate from lease to lease and with different tenants.
Understanding your lease is key
Both landlords and tenants must understand the pros and cons of each type of commercial lease so they can enter into an agreement that serves both parties.
Before you advertise your property for lease (or sign a lease as a tenant), closely evaluate the lease agreement to understand all of your responsibilities and rights; it can be a wise investment to have a real estate attorney review the lease before it’s finalized.