The Different Types of Leases
While leases can vary widely from one property to the next, there are several types of leases which are commonly found in commercial real estate. Since every lease can be different, the most important things for a tenant and landlord to understand are which expenses are covered in the lease and which are excluded.
Before going into the types of lease structures, it’s worthwhile to consider the various expenses which a tenant or landlord might incur in a lease. They include, but are not limited to, property taxes, property insurance, exterior maintenance (exterior lights, landscaping, parking lot and so on), interior maintenance (heating, ventilation and air conditioning – also called HVAC –, carpet cleaning, plumbing, electrical, and so on), janitorial, utilities (electricity, gas, water, sewer, telephone, internet, and so on), plate glass, roof, and structural maintenance. Knowing which side of the ledger an expense falls – landlord’s or tenant’s – means knowing how to predict the cost to rent a property.
A lease structure often depends on the landlord’s preference and what is common in the market place. Some leases push all the expenses to the tenant’s side of the ledger, while other leases push all the expenses to the landlord’s side; and then there are many lease types in the middle. Here are some common lease structures.
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 tenant on a long-term lease. The tenant is often a large corporation that knows clearly what it’s entering, 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
A triple net lease is typically 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 over and above the base rental rate. This extra charge is sometimes referred to as TICAM (taxes, insurance and common area maintenance). Often identified as an “NNN Lease”, a triple net lease 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 their pro-rata share of the operating expenses. Tenants are usually afforded the right to audit the landlord’s operating expenses under this lease structure.
In triple net leases, tenants usually pay their own janitorial expenses, interior maintenance expenses (such as HVAC maintenance) and their own utilities. If utilities are not separately metered, then the tenant pays its pro-rata share of the expense. Landlords usually 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 limit its risk of rising 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.
Full Service Lease
Just as the name implies, a full service lease covers all – or most – 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.
In closing, both landlords and tenants must take the time to understand the lease contracts they enter into. Likewise, both landlords and tenants stand to realize value by engaging the services of a commercial real estate professional to represent them in a transaction. Contact a team member at Harris Morrison Company to discuss how we can advise on leasing a commercial property.