There are many different considerations when it comes time to execute a commercial property lease. One very important consideration is the structure of the lease with regard to the sharing or responsibility of property expenses between the landlord and the tenant. Further, when comparing lease rates it can be very challenging to compare apples to apples due to the different types of lease structures. Some rental rates may appear lower than others but the tenant may be responsible for a larger amount of property expenses. Conversely other rates may seem higher but the rate may include all or part of the property’s operational expenses.
Basic Commercial Lease Types
The most common lease structure in newer commercial properties is what is known as a triple net lease. In this lease structure virtually all costs associated with the property, including real estate taxes, property insurance and maintenance costs are passed through to the tenant on a pro rata basis on top of the base rent. In a single tenant building, the tenant would pay for all operating expenses. The triple net lease is one of four main types of leases. A gross lease is one where the rent paid by the tenant includes the three previously stated expenses … taxes, insurance and maintenance. A gross lease can be modified however. For instance the tenant may also be responsible for utilities and janitorial. This lease is called a full service lease.
There is one level greater than the triple net lease and that is known as a bondable lease or bond lease which is also known as an absolute net lease. In this structure the tenant is completely responsible for any and all costs under any circumstances. This includes roof and structural issues as well repairs to any building damage, even if it is totally destroyed. This type of lease is common in very strong markets or with single tenant headquarter or institutional leases. There are also expense stops to consider which locks in the landlords expense to the base year level of the first lease year and pass on any increases in that expense over the lease term to the tenant. This is common in industrial properties.
Triple Net Lease Operating Expense Illustration
A single net lease means the tenant also pays the relevant property taxes. A double net lease means the tenant pays property taxes plus building insurance. This brings us to the triple net lease where as stated, the tenant pays for all three; Real estate taxes, property taxes and maintenance. A triple net lease illustration is provided below for reference.
$ 30.00/SF – Base Rent
+ $4.00/SF – RE Taxes
+ $1.50/SF – Property Insurance
+ $1.75/SF – Maintenance & Repairs
= $37.25/SF – Total Lease Costs/Responsibility of Tenant
So What Type of Lease Should I Select?
That depends. Triple net leases favor the landlord in my opinion because it shifts all risk associated with rising expenses to the tenant. Landlords typically prefer this lease structure as it helps limit uncertainty/risks related to property expense increases and many large property owners (REIT’s, institutional investors, etc.) lease property to tenants on a triple net basis or similar terms. Gross or full service leases favor the tenant for the opposite reason. The landlord absorbs all the risk of rising expenses and utility use. From a tenants standpoint there are also certain expenses in a triple net lease structure that may not be fully tax deductible whereas a gross rent may be entirely deductible. Some tenants prefer simplicity. They just want to pay one amount every month and not worry about pro rata expenses calculations. It really comes down to personal choice and business planning. From a landlords perspective a property with all triple net leases may be worth more than an identical property with gross leases due to the lesser risk and resulting lower overall capitalization rates. Regardless of the property type or your position in the transaction understanding how the property expenses are being paid for/shared is an important item and hiring the right professional to represent you is highly recommended.
Walter Duke + Partners provides valuable analysis and critical information to landlords and tenants regarding commercial lease renewal and new lease executions. We perform the necessary market research and analysis to assist your legal, brokerage and accounting team with the negotiation or renegotiation of a commercial lease and put you in the best position to succeed.