Explaining the Various Types of Commercial Real Estate Leases

Signing a commercial lease agreement

When it comes time to expand your business to your first office or upgrade to a more suitable location, there’s plenty to worry about. Budgetary concerns, logistics, and ensuring continuity of business during the relocation are all crucial elements. Before you consider how you’ll move, you should investigate your commercial real estate lease options to ensure your company enters into the right agreement for the right stage of your business.

Different Types of Commercial Real Estate Leases

There are three basic types of commercial real estate lease agreements. In each lease type, rent is calculated by one of two methods: net or gross. Net lease agreements mean tenants enjoy a smaller base rent, but are responsible for more utilities and upkeep costs. Gross leases tend to cost more per month, but leave expenses like property taxes, building upkeep, and utilities in the hands of the landlord.

Let’s explore each commercial real estate lease type in greater detail:

Gross Lease (or Full Service Lease)

In a gross lease agreement, a tenant’s monthly rent covers all operating expenses, which usually include property taxes, utilities, janitorial, and common area maintenance (CAM) costs. It’s important to note that CAM fees generally cover any fees related to the maintenance of the property’s site – such as elevators, lobbies, hallways, parking lots, and landscaping. As a result, the rent is relatively high, but the monthly cost is reliable and consistent, allowing tenants to budget the same amount each month.

Despite the “no frills” nature of these lease types, many landlords will include escalation clauses in the lease agreements to account for any unforeseen increases in insurance or property tax costs. They may also include variable cost increases for utilities, so during seasons like summer or winter, you may see a larger rent to account for heating or air conditioning costs.

These lease types are typically the most convenient and beneficial for tenants, allowing them a simple, predictable monthly expense without having to worry about unexpected costs or sudden expenses. Landlords assume the full responsibility for non-rent expenses while tenants are able to fully concentrate on their business.

Net Lease

Highly adjustable and highly varied, net leases are a common type of commercial real estate lease in which the base rent for tenants tends to be lower than that of gross lease agreements, but the tenant is made responsible for fixed operating costs like insurance, CAM fees, utilities, and property taxes.

There are four types of net leases:

Single Net Lease – Tenants pay set rent costs and property taxes, which are calculated based on the portion of the building leased by the tenant, as well as utilities. The landlord covers insurance fees and building expenses.

Double Net Lease – This is similar to a single net lease, except tenants pay both a portion of the property insurance and the building’s property taxes in addition to rent. Landlords cover the maintenance of the common areas, but tenants are still responsible for utility costs.

Triple Net Lease – Triple net leases encompass part of the costs of the property taxes, common area maintenance, and property insurance on the part of tenants.

Triple net leases are among the most popular types of net leases for industrial and retail properties. Landlords estimate expenses based on the tenant’s proportionate, or pro-rata, share. For example, if a tenant takes up 25% of a building’s available space, the landlord would charge the tenant for one-quarter of the building’s monthly property taxes, insurance, and CAM fees.

These lease types are also more landlord-friendly, so tenants should check triple net lease agreements for fees before agreeing to any terms. It’s not uncommon for tenants to ask for limitations on the annual increases in costs, but because these costs can change month-to-month or year-over-year, it can be difficult to predict how much your space will cost your company. However, being able to directly see the monthly costs of operating expenses will help your company predict the overhead increases of any future expansions in staff, equipment, or square footage.

Absolute Triple Net Lease – The tenant takes full responsibility for costs of rent, property taxes and insurance, and building maintenance. Most of the time, buying a property outright is a better option and therefore makes it a very uncommon type of commercial real estate lease agreement.

Modified Gross (or Modified Net Lease)

A modified gross (or modified net) lease allows for a comfortable middle ground between the needs of tenants and landlords. These lease types are similar to gross leases in that rent can be collected in a single payment, sometimes including any or all of the net expenses (property insurance, taxes, and maintenance). In modified gross or net leases, utilities are often covered by the tenant. However, these lease agreements are highly adjustable and terms are specific to each contract and additional costs are negotiated between landlords and tenants.

Percentage Lease

Percentage leases require tenants to pay a base rent and, in addition, pay the landlord a monthly percentage based on the tenant’s sales. These are commonly associated with retail spaces like malls, mixed use buildings, and shopping centers with high foot traffic. 

Thanks to an abundant market and a thriving economic landscape, businesses of every size and scale should strongly consider their expansion or relocation opportunities – especially if there’s a large real estate inventory in your area. From predictable rents commonly found in gross leases to potentially more affordable options in net leases or somewhere in between, negotiating the best possible commercial lease agreement for your company’s situation and budget is among the most crucial elements in the process. And now that you understand the various types of commercial real estate lease agreements, you, your team, your broker, and your lawyer can begin your search for the perfect office space to help you grow and expand your business into the future.

 

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