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In many commercial real estate situations, the rental income stream of a property dictates the value of the property. That cap rate multiplier that governs the value is based on the net operating income of the property, governed by the total monies generated. Leases generally fall into two categories: gross or net. Prospective tenants need to know which of the two they are signing up for. Landlords will generally need to maximize the potential revenue generated by their property, and these different types of leases provide them with different methods to do so. Historically, office leases have fallen into the gross lease category, while retail leases have fallen into the net lease category. Each category has variations, but the main types are listed below.
Lease Types: Gross
Gross Leases – A gross lease is one in which the tenant pays the landlord one total rent amount. That amount is intended to compensate the landlord for all occupancy costs including the tenant’s base rent for the right to occupy the premises, but also includes operating expenses, real estate taxes, insurance, utilities and the like. The tenant is not expected to pay any other sum or amount for its occupancy of the premises.
Modified Gross Leases – A modified gross lease is one in which one fixed rent amount is paid, but that fixed amount of rent includes all occupancy costs, including base rent and operating expenses, real estate taxes, insurance, utilities, and the like for the first year of the lease term. The first year of the term acts as the “Base Year” for establishing the operating expenses, real estate taxes, insurance, utilities, and the like amount for the premises.
Let’s say those additional costs over base rent for the first year of the term were $10.00 a foot. Historically, operating expenses, real estate taxes, insurance, utilities and the like increase yearly. In this type of lease, the landlord is entitled to increase the “rent” collected from the tenant not only by any base rent increases negotiated in the lease but also increase the sums due from the tenant by the amount of any increases in operating expenses, real estate taxes, insurance, utilities and the like each year of the term, over the amount of those items from the prior year. In our example, if in year two of the term, the additional costs increased to $10.50 a foot, the landlord would be entitled to charge the tenant an extra .50 for year two, and if in year three, those additional costs increased again by .70, over the costs for year two, again increase the rent by those .70. And this recurs every lease year.
Lease Types: Net
Net, Net Net or Net Net Net Lease – A net lease is one in which the tenant pays the landlord one fixed rent (usually referred to as “base” or “minimum” rent) plus the tenant’s proportionate share of real estate taxes for the property. A net net lease is one in which the tenant pays the landlord a fixed base rent amount plus the tenant’s proportionate share of the real estate taxes and the landlord’s insurance costs. The last variation, which is the most common, is the triple net, also referred to as a net net net lease. This is where the tenant pays the landlord a fixed base rent amount plus the tenant’s proportionate share of the real estate taxes, landlord’s insurance costs and operating expenses for the property.
Conclusion
It is essential that during the initial discussions for the rental of any premises, the tenant clearly understands the structure of the rental obligations and what the tenant is getting for their “rent” payment. Otherwise, the total occupancy cost for the premises could result in a much higher amount than originally expected.