April 19, 2020

Lease Structures 101

Introduction

In an office building, there are two types of lease structures that landlords most commonly use. These two categories are gross and net. The main difference between the two is how the rent is calculated and how the operating expenses for the building are accounted for.

In a gross lease, the tenant is responsible for paying one monthly rent check that includes all occupancy costs. In a net lease, the tenant pays the base rent in addition to a percentage (known as the pro rata share) of operating expenses for the building. While tenants usually can’t choose the type of lease structure used, it’s important to recognize how each one functions and how it will affect your occupancy costs. We will explain the mechanics of each lease structure in further detail below.


Gross Leases

As we mentioned, in a gross lease structure, also known as a full-service lease, the tenant pays one monthly rate that includes all occupancy costs. The landlord pays all of the operating costs of the building, including property taxes, insurance, and maintenance. The biggest benefit to a tenant in this type of lease structure is that occupancy costs are very predictable throughout the lease term, allowing tenants to forecast expenses for the duration of the lease.

A slight variation on the gross lease is the modified gross lease. This structure functions similarly to a gross lease, but certain expenses – for example, utilities and janitorial – are not included and are instead the responsibility of each tenant.

In both the gross and modified gross lease structures, landlords will often insert a base year provision, which allows an incremental portion of the occupancy costs to be passed on to the tenant. For more information on base years and how they function, see our previous blog post here.


Net Leases

The net lease structure can take many forms. Ranging from a single net lease to a triple net lease, this lease structure allows the landlord to recover the operating cost of the building directly from each tenant. For the purposes of this discussion we will focus on the triple net (NNN) lease, as it is the most common type of net lease. The nets refer to operating expenses that the tenant pays in addition to the base rent. In the NNN lease structure, tenants pay a base rent each month and an additional payment for operating expenses. The operating expenses typically include property taxes, insurance, and common area maintenance. The amount that a tenant pays is based upon the pro rata share. The quoted lease rate will often be lower than the quoted rate of a gross lease, because operating expenses in a triple net lease are quoted separately.

For instance, if a tenant occupies 2,500 SF in a 10,000 SF building, the tenant’s pro rata share is 25% (2,500/10,000). If the operating expenses for the building are $50,000 for the year, the tenant reimburses the landlord $12,500, or $1,042 per month, in addition to the base rent. This type of lease offers the landlord more assurance that their operating costs will be fully reimbursed. For tenants, the triple net lease structure has less predictability, because the operating costs can vary from year to year. In recent years the triple net lease has become more popular among landlords because of the ability to recover operating costs.


Conclusion

Recognizing how each lease structure functions and how it will impact your business’s occupancy costs is critical. You should have an understanding of what costs you are responsible for and how they are going to be billed. Having the right representation to advise and assist you through the leasing process can help save you time and money. The tenant advisory team at NAI Elliott specializes in assisting tenants before, during, and after the leasing process. Feel free to give us a call!


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© 2020 NAI Elliott - All Rights Reserved

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