What are the Different Types of Commercial Leases?
An important part of underwriting a property’s cash flow is understanding the nuances of different commercial lease types. Did you know there are actually three (3) different types of leases?
- Gross Lease
- Modified Gross Lease (also referred to as Double Net)
- Net Lease (also referred to as NNN)
All leases outline the rental obligation of the tenant and will be broken down into two categories;
a) Base Rent – the rent PSF a tenant will pay for their space
b) Reimbursements — taxes, insurance and common area charges (aka CAM)
What are the differences between different types of commercial leases?
Gross Lease means the tenant is responsible for paying the landlord the Base Rent ONLY and is NOT responsible for any CAM or other Reimbursements. This type of lease favors the tenant because as the property’s operating costs increase, the tenant will only be responsible for their agreed upon Base Rent.
Modified Gross Lease occupies the middle ground between a gross lease and a triple net lease. In general, a modified gross lease means that the tenant pays base rent, utilities and a portion of operating costs. Of course, the details vary from lease to lease. Other leases that fall within this category are leases that require the tenant to pay their proportionate share of all CAM and Operating Expenses in excess of their initial lease year (Base Year Expenses).
Net Leases are a popular tool for commercial real estate investors who want to have a stable income stream. The property owner charges less base rent, but gets to shift the burden of the operating expenses to the tenant. The three (3) primary types of net leases that deal with the main cost categories of taxes, maintenance and insurance — which is over and above Base Rent, are Single, Double and Triple Net Leases.
But what does single, double, or triple net lease actually mean?
It simply means that when a tenant signs a single net lease, they pay one of the three expense categories. Tenants who have a double net lease (NN), pay two of the three expense categories. And in a triple net lease (NNN), the tenant pays all three expense categories.
Net Leases should not be confused with an Absolute Triple Net Lease; which is essentially the same thing as a standard triple net lease in terms of what the tenant is responsible for paying, but the major difference is that the tenant pays these expenses directly. Unlike the other net leases, the expenses are billed directly to the tenant and they do not reimburse the landlord. Their share of expenses would likely be based on the percentage of the building that they occupy. For example, a tenant occupying 50% of a building would be responsible for 50% of its operating costs.
So, are you more knowledgeable about commercial leases now? Hmmm. Let’s do a quick re-cap.
|(Gross) Lease||Tenant pays base rent. Landlord covers all operating expenses of the property.||Any commercial space|
|Modified Gross Lease||Tenant pays rent PLUS a portion of the building’s annual operating expenses. Reimbursement amounts can vary widely.||Any commercial space|
|Net Lease||Tenant pays rent PLUS some degree of taxes, insurance and operating expenses. Types include single, double, and triple.||Any commercial space|
|Single Net Lease||Tenant pays rent PLUS property taxes.||Any commercial space|
|Double Net Lease||Tenant pays rent PLUS taxes and insurance.||Any commercial space|
|Triple Net Lease||Tenant pays rent PLUS taxes, insurance, and other operating expenses.||Any commercial space|
|Absolute Lease||Tenant pays rent PLUS all building expenses (taxes, insurance, maintenance), including roof and structure repairs.||Long-term leases to credit tenants|
When evaluating commercial leasing options, it is essential to compare the different types with an eye toward all expenses and not just the base rental rates.
The most important rule of commercial leasing is for Landlords to read their leases carefully and clarify exactly what expenses they are responsible for and what can be passed along to the Tenant.
Eddie Miro is a Financial Analyst at Progress Capital and is available to advise you on any commercial real estate investments you are considering, as well as help you manage through the commercial real estate acquisition and/or financing process.