In the commercial real estate market, there is confusion from potential tenants over the many different type of leases and different terminology that is used for similar meanings. To simplify the process, below are the three basic types of leases one may encounter while looking to lease commercial property: Gross, Modified Gross and Triple Net (NNN). As you will see below, these are the typical terms used to define the majority of leases, but most likely you shall hear multiple terms for the same type lease. However, most leases will fit into one of these types. Most leases, no matter what type of category they fall into, are calculated on a per square foot (SQ FT) price basis. Meaning, the monthly lease rate or price is an annualized cost per foot multiplied times the number of square feet leased. If the landlord is asking $15 per SQ FT and you are leasing 1,000 SQ FT of space, the asking lease rate will be $15.00 per square foot times 1,000 SQ FT or $15,000 on an annual basis. Simply divide that amount by 12 months a year and you will have your base rent on a monthly basis, in this example that would be $1,250.00 per month as your base rent, then depending on the type of lease you will be able to know what to budget for the property you are looking at. Now let’s look at the various types of leases one may encounter in the market place.
- Gross Lease—In a Gross Lease, all expenses are included in the base rent, i.e. heat, electric, real estate taxes, maintenance, landscaping, plowing, water/sewer and building insurance. The only other bill the tenant would be responsible for is for phone/internet service (which is never included). A Gross Lease is a typical lease for office space where the utilities are not separately metered, especially older buildings, with multiple tenants. With this type of lease, it allows a tenant to know exactly what their annual expense will be, so you may budget precisely for the area they are interested in leasing.Gross leases are typical in office leasing. In this type of leasing structure, there is a common area recapture amount. Since all expenses are included in the rent, the landlord needs to charge for the cost to maintain common areas: hallways, elevators, restrooms and entryways. He also needs to recapture income for those areas, and since they are not leasable by themselves, yet all tenants in the building use them It is recaptured as “rentable square footage”. In these type leases, and modified gross as well, which is the next type lease discussed, there is “rentable square footage” versus “usable square footage”. Rentable square footage is what tenants pay for; usable square footage is what tenants, in actuality, receives to use under the lease for their space, not including common area. On average, buildings have between 12-18% common areas; that percentage of space gets added to the usable amount. For example, if usable space is 1,000 SQ FT and the building has a 15% common area factor, the rentable space (total square footage on the lease and paid for in lease calculation) is 1,150 SQ FT.
- Modified Gross Lease. In a Modified Gross Lease, the tenant is responsible for heat and electric in addition to the base rental amount. That is the only difference between a Gross lease and a Modified Gross lease. The utilities (gas, electric and occasionally oil) are typically billed directly by utility company to the tenant. Also, typically they are separately metered for each tenant, so the usage is not an estimate. More modern and recently built structures are this way. Everything else (as listed in gross lease definition) is included in the base rent. Once again, the tenants only responsibility outside the base rent would be the utilities they actually use and of course telephone/internet service which is never included. Occasionally a building that is not separately metered will also be a modified gross lease, to attempt to keep utilities costs down by the trying to control the tenant’s usage. This is done on a prorated basis using square footage as a measure. For instance, if you leased ten thousand (10,000) SQ FT in a hundred thousand (100,000) SQ FT building, you would be leasing ten percent (10 %) of the building, therefore responsible for ten percent (10 %) of the utilities cost. A Modified Gross Lease is a typical lease for retail space as well as newer office buildings.
- Triple Net (NNN) Lease. In an NNN lease, you have your basic rental rate called base rent, as with all leases, which solely is the price for the space. There are typically no expenses what so ever included in the base rent. All expenses are borne by the tenant. This is addition to the utilities expenses as explained above. In a multi-tenant complex, similarly to utilities, each tenant is billed by the landlord for their pro-rated percentage of space. For example, in a 10,000 square foot building where a tenant is leasing 2,000 SQ FT, the tenant occupies 20 % of the building and then that tenant would be responsible for 20% of all expenses. Typically, in the lease agreement, the tenant has the right to review all invoices for which they are billed once a year. Most landlords charge the NNN amount on a monthly basis and that amount is adjusted annually based on the previous year’s expenses. NNN leases are typical for warehouse/industrial space.
That explains all the types of commercial leases in a short version. As mentioned, you occasionally will run into some type of modifications, but the vast majority should be one of the above.
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Should you have any questions about this article – or any commercial real estate matter – please feel free to contact me at [email protected] or call me at 508-635-6787.