Commercial Leases can be confusing: What are triple net, full service gross, And modified
gross leases? Today we’re talking about commercial lease structures and the differences
between each one. ________________
Commercial real estate, like many other industries, is full of its own lingo.
If you’re looking to lease commercial space, you’ve likely run across phrases such as
“triple net” or “full-service” whenever a broker or landlord explains what type of
lease they’re using. But what does that actually mean?
And, maybe a better question, why are certain lease structures utilized instead of others?
Let’s dive into what triple net (NNN), full-service gross (FSG), and modified gross (MG) mean
and the differences between them. ________________
Triple Net (NNN) Leases In A Triple Net Lease, the Tenant Pays The
Operating Expenses. ________________
These leases are traditionally found in retail and standalone properties.
However, in recent years, the triple net lease structure is also finding its way into office
and industrial, too. NNN stands for the three “nets” in the
lease: * Common area maintenance (CAM)
* Property taxes * Building insurance
In these leases, tenants are responsible for paying their proportionate share of these
fees in addition to their base rent, utilities, and any maintenance within their premises.
Rents for a NNN lease may be quoted as “$30 per square foot triple net, with $5 per square
foot in pass-throughs.” Why Are NNN Leases Used?
Why would tenants sign a triple net lease and accept all of the responsibility for those
expenses? Well, more often than not, this structure
is actually beneficial to them and the landlord. Landlords prefer this structure, if possible,
because any increases in property taxes, building insurance, common area maintenance, and more
will get passed on directly to the tenant that benefits from the use of the property.
Tenants prefer NNN leases because they know that the additional rent they pay towards
maintaining the common areas will be utilized properly.
Landlords don’t, or at least shouldn’t, make money off the pass-through fees.
Tenants may also audit these expenses annually, so the landlords won’t be tempted to cut
costs on the quality of the maintenance of the property.
In retail, image is everything, and it ensures the property is well groomed.
Full-Service Gross (FSG) Leases IN a full-service gross lease, the Landlord
Pays The Operating Expenses ________________
Full-service gross leases are most commonly found in office buildings, but can also be
found in lower-quality retail and industrial centers.
Since this lease type is the most simple of the three, it is often used by more unsophisticated
landlords on all property types. FSG means pretty much as it sounds: the lease
covers all expenses. That means that the tenant pays the landlord
one fee, their rent, and the landlord pays any and all expenses on the property, such
as: * Utilities
* Common area maintenance, taxes, insurance (the three nets)
* Janitorial and more. Landlords or their property management company
will be responsible for anything and everything that needs to be maintained in the building,
which can even include changing light bulbs for tenants.
Rents for a full-service lease may be quoted as “$30 per square foot, full-service.”
Why are full-service Leases Used? Full-service leases are very straightforward
and easy to understand. The tenant is responsible for paying their
rent and the landlord is responsible for all other expenses and maintenance.
So, would tenants prefer this lease structure then?
Depending on the sophistication of the tenant and the landlord, maybe.
Since the landlord is responsible for coordinating maintenance, handling repairs, and restocking
supplies, they could take these opportunities to cut costs in order to make more money.
Unfortunately, landlords like that are the reason why some buildings fall into disrepair.
However, these lease structures can be great for tenants since they are only responsible
for paying rent and can lean on the landlord for everything else.
Modified Gross Leases In a modified gross lease, the Landlord And
Tenant both Pay Operating Expenses ________________
Modified gross leases are a hybrid of the triple net and full-service lease structures.
There is no “guide” as to which responsibilities fall on the landlord or the tenant in this
scenario, as it can vary depending on the sophistication of the landlord, the type of
business the tenant operates, the style of property, and more.
As a hybrid between NNN and FSG, modified gross can pass on any number of the expenses
or responsibilities to either party: * Landlord may pay taxes while tenant pays
CAM, insurance, utilities * Landlord may pay everything except for the
tenant’s utilities * Utilities may be included in rent but CAM
is not There’s really no limitation as to how these
leases may be set up. Rent on a modified gross lease may be quoted
as “$30 per square foot plus tenant’s pro-rata share of CAM.”
Why Are modified gross Leases Used? Modified gross leases offer far more flexibility
for both parties during negotiations. It may also be easier for the landlord to
set up the lease payments this way, depending on how the property was constructed or set
up prior to their acquisition. Some landlords prefer to cover the “more
controllable” costs, such as insurance, while passing off the “uncontrollable”
expenses, like utilities, on to the tenant. Modified gross leases may be used on any type
of real estate and can be a good compromise for both the landlord and the tenant depending
on the scenario. So, Which Commercial Lease Structure Is Right
For You? ________________
Unfortunately, that’s a very difficult question to answer.
The best response to just about every question in commercial real estate is “it depends.”
As you can tell, there are pros and cons for both parties in all three lease structures,
so the market may help decide which route should be taken.
If all of the leases for comparable properties are modified gross, you may have a difficult
time instituting a triple net lease, unless the expenses end up being around the same
price. As always, consult your commercial broker,
real estate attorney, and CPA when deciding which path is best for you and your venture.
There you have it for the commercial lease structures and what they mean. For more leasing
tips, check out this playlist here. Don’t forget to like the video and subscribe to
the channel for more commercial real estate investing strategies, leasing and management
tips, market updates and more.