There are five types of commercial real estate (CRE) leases. By being fully aware of the distinctions between various kinds, you, as a landlord, can position your properties more effectively and maximize your earnings.
This blog looks at the different kinds of commercial real estate leases and their defining characteristics. The typical standards for each lease type are listed below, but remember that while each lease category will give a sense of your anticipated costs, there are no set rules.
1. Full-Service Lease (also called Gross Lease)
The most common type of lease for office buildings occupied by multiple tenants is the full-service or gross lease. In this arrangement, you, as the landlord, are responsible for paying all expenses associated with the building, including repairs, utilities, property taxes and insurance, and janitorial services. In addition, you take on the responsibility of properly maintaining the building.
While this results in relatively high rental rates, it’s also simpler for the tenant. They only receive one bill that covers all necessary office expenses. There are no hidden costs, making it easier for them to forecast their lease payments. This arrangement is also ideal for tenants who want to avoid getting involved in running an office property.
2. Net Lease
In a net lease, you, as the landlord, can charge a lower annual rent (compared to what you would charge a tenant in a full-service lease). However, you can charge for monthly “usual costs,” including property taxes and insurance, common area maintenance items (called CAMS), and prorated costs.
Landlords usually determine each occupant’s proportionate share of recurrent operating charges this way: They determine the cost per square foot of all rentable areas and then distribute this amount among tenants based on the proportion of the property each tenant occupies.
Net leases can either be single, double, or triple. Different financial obligation levels characterize each type the landlord passes onto the tenant.
- Single net lease – In a single net lease, the tenant pays rent in addition to their pro-rata share of the office building’s property taxes. As the landlord, you are responsible for insurance and upkeep. Note: It’s easy to confuse a single net lease with a net lease, but they’re not the same. Net lease is an umbrella term for several leases (single, double, and triple).
- Double net lease – The tenant pays rent, property taxes, and part of the building insurance in a double net lease. As the landlord, you pay directly for the property’s structural maintenance expenses. The base rent in this type of lease is generally lower because the tenant pays for additional costs.
- Triple net lease (also called NNN lease) – In this type of lease, the pro-rata share of property taxes, property insurance, rent, utilities, and CAMS are all paid by the tenant. This landlord-friendly lease is most often used for restaurants or retail establishments. Triple net leases frequently offer reduced rental rates since the tenant has assumed responsibility for the running costs. Also called NNN leases, triple net leases are long-term and have provisions for rent increases written into them.
Do note that some tenants may attempt to renegotiate or terminate their leases when maintenance costs are higher than anticipated. To prevent this problem, you as a landlord can use a “bondable” net lease, where you and the tenant agree that the lease cannot be ended early, nor can the rent amount be increased before the end of the contract’s term.
3. Modified Gross Lease
A modified gross lease is a compromise between the full-service and net lease. For example, a tenant might pay for their portion of their property taxes, property insurance, and CAMS, but they pay it as a lump sum payment along with their rent.
In this arrangement, the rent is set, and there are no hidden costs or unexpected charges. The rent stays consistent even if the taxes, insurance, or CAMS rates rise. In addition, with a modified gross lease, the landlord covers electricity and cleaning services.
The specifics depend on the agreement. For example, in some modified gross leases, tenants pay only base rent and utilities for the first year but pay a pro-rata share of the building’s operating costs in each additional year.
The percentage of the property that a tenant occupies is used to compute their portion of expenditures. For example, tenants who utilize half of a property will be responsible for half of the facility’s operating costs.
4. Absolute NNN Lease
Although they’re often used interchangeably, an absolute NNN lease is not identical to a triple-net lease. Triple net leases require tenants to cover some or all building maintenance costs, such as structural or roof repairs, but the landlord will assist with those expenditures in some cases.
In contrast, an absolute NNN lease frees the landlord from any responsibility for the property’s expenses. This means that the tenant assumes all building expenses, like any upkeep or fixes to the roof and structure of the building.
As a result, the base rent for an absolute NNN lease is generally far lower than other leases. Essentially, the tenant completely controls the facility without having to purchase it. As a result, this lease is quite rare and is usually only available to long-term tenants with a national or regional presence and excellent credit.
5. Percentage Lease
This is the typical lease type for retail mall outlets. A percentage lease is one in which tenants pay a base rent and a certain percentage of their gross business sales (once total sales exceed a set amount).
For example, landlords usually ask for 7% of the store’s monthly sales. Percentage leases usually involve lower base rents than standard leases because the tenant consents to pay a portion of sales.
Drafting a commercial real estate lease
While they’re not set in stone, these commercial real estate lease categories give you a ballpark idea of what to expect regarding cost and terms. Every contract is unique and negotiable.
Bigger tenants will typically work with a tenant representative or lawyer who scrutinizes the contract and reads the small print. But, of course, it’s best to have your lawyer, too.
An experienced commercial real estate lawyer can help you write a lease agreement that provides the appropriate safeguards depending on the sort of property you’re renting out and how the tenants plan to use it.
For example, they can determine if it should include specific provisions on subleasing, dispute resolution indemnity, insurance, etc.
A lawyer can also help make your commercial real estate business more profitable. For example, they might advise you to add certain terms to your commercial lease agreement to make your property more appealing to potential tenants who want the freedom to improve or modify it.
These terms may include applicable restrictions, a clear approval process for proposed improvements, stipulations for removing improvements when the tenancy ends, designation of maintenance and repair responsibilities for parts of the building that will be modified, and designation of responsibility for damages, among others.
It’s critical to have clauses/specifications in your business real estate lease agreement that address who is responsible for anticipated and unanticipated expenditures, including utilities and repairs not connected with development or expansions. Doing this can help you avoid legal disputes later on.
Not only is it important to have clearly defined expectations for tenants, but you must also include set consequences for if and when they violate the terms of the lease agreement. This includes missing or late payments, among other things. And in the event of a breach or dispute, it should be clear who is responsible for paying attorney’s fees.
Some landlords—especially those new to CRE and who come from a residential leasing background—make the mistake of believing they can manage the legal and financial complications of a CRE deal on their own to save time and money. Unfortunately, this could not be more wrong, especially regarding commercial lease agreements.
Running a commercial real estate leasing business is complicated. Even seasoned landlords might face stressful and costly surprises if they take shortcuts or attempt to write their commercial lease agreement. It’s best to consult a lawyer when drafting your CRE leases to prevent legal headaches.