While leases can vary widely from one property to the next, there are several types of leases that are commonly found in commercial real estate. Because lease terms vary, the most important thing for a tenant and landlord to understand is which expenses are covered in the lease and which are excluded. This information also aids in understanding what types of negotiations will appeal most to a tenant or a landlord.
Most often, tenants want a “fixturization period” or a free rent period. This can help a new business, as they are always in need of cash flow in the beginning. A landlord is focused on signing a long-term tenant because the longer the term the more tenant improvements or negotiation on rates and terms are likely to get accepted.
It is important to consider the various types of expenses that a tenant or landlord might incur in a lease, which are completely different than your typical residential lease.
They include but are not limited to property taxes, property insurance, exterior maintenance (exterior lights, landscaping, parking lot, etc.), interior maintenance (HVAC system, carpet cleaning, plumbing, electrical, etc.), janitorial, utilities (electricity, gas, water, sewer, telephone, internet, etc.), plate glass, roof, and structural maintenance. The importance of these details cannot be overlooked when considering a business’ or landlord’s overhead. With accurate information, a landlord and tenant are in a position to be able to estimate the cost to rent and also own property.
A lease structure often depends on the landlord’s preference and what is common in the marketplace. Some leases push all the expenses to the tenant’s side, others push all the expenses to the landlord, but there are also many lease types that are right in the middle. The following are some common lease structures to know that will better prepare you for your next deal.
Absolute Net Lease
An absolute net lease typically pushes all the expenses to the tenant, including taxes, insurance, maintenance, roof, structural, and parking lot maintenance and repair. This lease typically occurs on a single tenant building, which a landlord builds to the tenant’s specifications, and then turns over to the tenant on a long-term lease. The tenant is often a large corporation that knows clearly what it’s entering into and is prepared to take on all the expenses. Because the tenant takes all the operating risks, the landlord is willing to accept a lower rental rate.
Triple Net Lease or NNN
A triple net lease is typically the net of three expense categories: real property taxes, insurance, and maintenance. These expenses are often called operating expenses, or pass-through expenses because the landlord passes them through to the tenant in the form of additional rent that is over and above the base rental rate. This extra charge is sometimes referred to as OpEx (operating expenses, including taxes, insurance, and common area maintenance). This type of lease is often identified as an “NNN Lease” and can occur in a single-tenant or multi-tenant building.
If single-tenant, the tenant typically takes control of the landscaping and exterior upkeep, thus controlling the property’s appearance. If multi-tenant, the landlord typically controls exterior upkeep so that no single tenant can ruin the appearance for the others. In addition, tenants of multi-tenant buildings pay a pro-rata (or equal) share of the operating expenses based on the square footage the tenant occupies. Tenants are usually afforded the right to audit the landlord’s operating expenses under this lease structure.
Tenants usually pay their own janitorial expenses, interior maintenance expenses (such as HVAC maintenance), and their own utilities in triple net leases. If utilities are not separately metered, then the tenant pays its pro-rata share of the expense. Typically, a landlord will choose to pay to keep the roof and structural elements of the building in good condition.
In a triple net lease, the tenant bears the risk of paying property taxes, insurance and operating expenses, allowing the landlord to stabilize their own operating expenses.
Modified Gross Lease
A modified gross lease typically binds the landlord to pay the real property taxes, insurance, and common area maintenance, while the tenant takes responsibility for its own utilities, interior maintenance and janitorial. The landlord is usually responsible for roof and structural elements, just as in a triple net lease. Because the landlord is taking on more expenses than a triple net lease, the rental rate is higher than it would be under a net lease structure.
The advantage to the tenant of this lease structure is that the landlord takes on all the risk of rising operating expenses and manages many elements of operating the property including exterior maintenance. The tenant pays a relatively predictable rental rate and does not have to be involved in the real estate business. One potential disadvantage to the tenant is that the landlord may charge the tenant a premium to take on these expenses and risks, though this is not always the case.
Just as the name implies, a full-service lease covers all (or a large portion) of the operating expenses in a lease. Some of the few exceptions are telephone and data expenses. Otherwise, the landlord pays taxes, insurance, common area maintenance, interior maintenance, janitorial, utilities and so on. As a result, the rent is relatively high. These types of leases usually occur in large, multi-tenant office buildings where it is too difficult or cumbersome to divide up the utilities among tenants. The advantage to the tenant: one predictable rental payment without bearing any operating risks. The potential disadvantage is that the landlord may charge a premium to take on these expenses and risks. Many landlords appreciate this type of lease structure, as it gives them total control of the property’s appearance and maintenance.
Both the landlord and tenant need to carefully read and understand the lease contracts they are considering entering into. This is why working with an experienced Commercial Broker, who is most familiar with this lingo and how best to negotiate, is a crucial asset in achieving your business/real estate goals. Tru Commercial is more than happy to discuss how we can best advise you on leasing commercial property, email Heather@TRUcre.com to learn more.
Heather Binder is an accomplished real estate professional with Tru Realty in her role as the Director of the Commercial Division. She is dedicated to providing her clients with an extraordinary real estate experience. Her expertise in working with clients made Heather a natural for her role as a certified instructor at the Arizona School of Real Estate and Business.