Lease Types Explained

Leasing commercial real estate is an attractive option for businesses and individuals that are looking for lower upfront costs, but lessees must be aware of the various lease types and their benefits.

Leases go beyond monthly rent payments, and can include additional expenses such as property taxes, property insurance, and certain maintenance costs. It’s important for brokers, landlords, buyers, and tenants to understand the various lease structures.

Let’s take a look at the most common types of leases used in commercial real estate:

• Net Lease
  • Single Net Lease
  • NN (Double Net Lease)
  • NNN (Triple Net Lease)
  • Absolute Net Lease
• Gross Lease
  • Full-Service Lease
  • Modified Gross Lease
  • Base Year / Expense Stop Clause

Net Lease

A Net Lease is a type of commercial lease agreement in which the tenant pays a base rent, plus a portion of the property’s operating costs, such as taxes, insurance, and maintenance. The portion of expenses being paid is dependent on how much space is being rented. This type of lease structure allows the landlord more control and security over the property and is often used to pass on additional costs to the tenant. Typically, over time costs increase, causing Net Leases to be a more unpredictable option for tenants.

1. Single Net Lease
   1. A Single Net Lease is an agreement in which a tenant is responsible for monthly payments and one extra payment – the property tax. Under a Single Net Lease, the landlord is still responsible for the remaining operating expense involved with running the property. This structure is beneficial for the landlord because minimal risk is transferred over to the tenant. Tenants benefit by paying a lower base rent because they bear the case of the property taxes.
2. NN (Double Net Lease)
   1. A Double Net Lease is an arrangement in which a tenant pays a base rent to the landlord along with property taxes and premiums for insuring the building. Each month, the landlord receives the base rent plus the additional payments from the tenant. The tenant typically benefits from a lower base rent due to the added expenses.
3. NNN (Triple Net Lease)
   1. A Triple Net Lease is an agreement in which the tenant or lessee agrees to pay almost all the expenses of the property, including property taxes, building insurance, and common area maintenance fees associated with the property. This lease structure provides the landlord with a steady stream of income and protection against unexpected costs. Additionally, this relieves the landlord from the financial burden of these expenses and provides them with a more predictable income. The tenant benefits from this lease structure as well. By absorbing a portion of the taxes, insurance, and maintenance costs, a Triple Net Lease presents a lower monthly rent than other lease agreements. Additionally, tenants are able to negotiate an even lower base rent since landlords favor tenants with a solid track record of financial responsibility. Creditworthiness goes a long way when securing a space.
4. Absolute Net Lease
   1. An Absolute Net Lease is a lease agreement in which all financial responsibility is taken away from the landlord, and tenants are responsible for all maintenance, including major costs, like roof and structure. This lease structure is the most passive for investors as it generates a truly passive income stream.

Gross Lease

A Gross Lease is an agreement that requires the tenant to pay the property owner a flat rental fee for the space. The fee includes all of the costs associated with property ownership, including taxes, insurance, and utilities, which the landlord remains responsible for. However, as described in further detail below, gross leases can be modified in many ways, so be sure to read the details of the lease.

1. Full Service
   1. A Full-Service Gross Lease is an agreement in which the tenant pays a flat rental amount, and the landlord is responsible for all property taxes, insurance, and maintenance of the property. This structure simplifies the process of paying rent and makes it much easier for both the landlord and the tenant. With this type of lease, the rate of rent is typically higher because the landlord covers a majority of expenses. Full-Service Gross Leases are most often seen in multi-tenant office buildings; buildings where tenant utility usages are proportionate to their occupancy
2.  Modified Gross Lease

   1. A Modified Gross Lease is a blend between a Gross Lease and a Net Lease. Essentially, it’s a full-service Gross Lease with minor exceptions. In addition to their base rent, the tenant may also be responsible for utilities and other operating expenses, such as maintenance and taxes. Additionally, this is a flexible lease structure that allows landlords and tenants to specify exactly who is paying for what. A Modified Gross Lease might suit tenants who have a higher risk. For example, tenants with excessive electrical power requirements might use a Modified Gross Lease as some landlords might find this circumstance overly burdensome on a Full-Service Gross Lease.

3. Base Year / Expense Stop

   1. Base Year is a clause or section that could be included within both a Full-Service Gross Lease and/or a Modified Gross Lease.  The “base year” is generally the first year of a commercial rental period that sets a precedent for how much tenants will pay for building expenses for each subsequent year. Depending on the type of lease, during the first year, tenants either pay only for the base rent, or they pay for the base rent plus a projected building operation cost based on their percentage of occupancy.  The definition of base year might seem simple, but the base year rate is calculated in different ways depending on what kind of lease you are signing. In a Full-Service or Modified Gross Lease, tenants pay only base rent for the first year of the occupancy period, while the landlord pays for all the building’s operating expenses.  However, after the base year, the tenant is now responsible for paying their pro-rata (proportionate) share of the building’s operating expenses. Base year is crucial to any lease negotiation, and it’s important to review with your broker, and lawyer to ensure financial success. Since the base year is designed to favor landlords and protect them from excessive annual increases in operating expenses, when overlooked, it can cause considerable harm to a tenant’s bottom line. However, a prepared and educated tenant can protect themselves against unexpected increases in their pro-rata shares.

Understanding the various lease types in commercial real estate is crucial for businesses and individuals seeking flexible and cost-effective options. These diverse lease structures come with different financial responsibilities and benefits for tenants and landlords. By carefully considering and negotiating lease terms, both parties can ensure their interests are protected and make informed decisions. A comprehensive understanding of these lease types empowers individuals to navigate the commercial real estate market with confidence and optimize their leasing arrangements.