Commercial leases can take a variety of forms, which is often confusing for both landlords and tenants. Understanding the different types, especially the gross lease structure, is important when selecting the lease that best suits your needs.
One key distinction between lease types is how rent is calculated and paid. This article addresses the two most common types of leases — gross lease vs net lease — along with their various subtypes.
Gross Lease vs. Net Lease
The gross lease is the simplest form of commercial lease. In a gross lease, the tenant pays a flat rental fee. Meanwhile, the landlord covers all operating expenses, such as property taxes, insurance, utilities, maintenance, and common area maintenance (CAM). Rents are calculated by landlords to reasonably cover the operating costs of the premises.
In contrast, a net lease requires the tenant to pay for certain costs associated with the property, such as utilities, taxes, maintenance, and other expenses, along with the base rent. Net leases are among the most common form of commercial lease.
Types of Gross Leases
To make matters more complex, there are different types of both gross and net leases, each with their own advantages and disadvantages. In a fully service lease, the tenant is responsible only for the rent, while the landlord assumes responsibility for all other costs. This is the most straightforward gross lease.
A modified gross lease combines elements of a gross lease and a net lease. Generally, operating expenses, property taxes, and insurance are included in the initial base year rent. However, any increases in these expenses over the base year are charged to the tenant based on their pro-rata share. Landlords and tenants can also negotiate who is responsible for which costs.
Pros and Cons of a Gross Lease
Because the tenant pays one flat fee, gross leases are more straightforward. They are also more predictable, which can be very important when businesses are just starting out. Tenants can focus their time on their business rather than taking care of their leased space. While a fixed rental fee may be attractive to tenants, the tradeoff is often higher rent payments.
For landlords, a gross lease can be more burdensome to manage because you assume all of the administrative duties associated with paying operating expenses. It is also important to carefully calculate rent payments in a gross lease. If you fail to properly account for expenses, you may not generate enough revenue to cover your operating costs.
Types of Net Leases
Net leases allocate certain expenses to tenants and can also take several forms. There are three main sub-types of net leases, which are primarily defined by how many expense categories the tenant pays in addition to rent. Below is a brief summary:
- Single net lease: The tenant pays a lower base rent plus one expense category, typically property taxes.
- Double net lease: The tenant pays a base rent plus two expenses categories, typically property taxes and insurance. Double net leases are often used in industrial or warehouse spaces.
- Triple net lease: The tenant pays a base rent plus three expense categories, typically property taxes, insurance, and maintenance. Triple net leases are often used in freestanding retail or office buildings, along with large, single-tenant industrial properties, where tenants want greater control over the property.
In a net lease, landlords often remain responsible for certain expenses, such as major improvements and structural repairs. However, these issues are subject to negotiation. To reduce their risks, tenants can also negotiate the lease to include caps on certain expenses.
Pros and Cons of a Net Lease
For landlords, net leases provide a reliable source of income while shifting the burden of managing taxes, insurance, and other costs to the tenant. However, in exchange for not having to manage the day-to-day operations of the property, landlords generally must charge less in rent.
Similarly, the lower rent of a net lease can be attractive to tenants. However, tenants must be mindful that they are assuming the risk that the costs of maintenance, taxes, insurance, and other expenses may rise. Accordingly, tenants should ensure that the base rent adequately compensates for the risks that they are assuming from the landlord. Because net leases place maintenance costs on tenants, they also often have more freedom to customize their spaces.
Consult With an Experienced Commercial Leasing Attorney
Because each type of commercial lease has its own set of advantages and disadvantages, tenants and landlords should carefully consider what best suits their business needs and financial situation. In addition to weighing a gross lease vs net lease, you should also consider what subtype is best for your situation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
