All Leases Are Not the Same; A Quick Guide to Lease Terminology
When a business owner calls and asks the lease rate on a building or looks one up on a web site, he is often quoted the base rate with no explanation of additional costs that he may be responsible for paying. There are many different types of leases and these additional costs can vary significantly and make a huge difference on the total rent that a tenant ends up paying.
Most tenants who have rented a residential home or apartment are familiar with the Modified Gross Lease. In this lease, the landlord pays most of the expenses, such as real estate taxes, building insurance, interior maintenance, snow plowing and lawn care. The tenant is usually responsible for the utilities, telephone & internet. This can vary from lease to lease, so it is important to read the lease terms carefully. Some landlords will have the tenants pay maintenance of the mechanicals or minor repairs. The landlord may include some utilities such as the water and sewer costs. Either party might be responsible for trash collection.
Gross Leases are ones that have the Landlord paying the utilities in addition to the above expenses. Again, there are some variations as often the tenant will still pay for internet, telephones & interior janitorial for the space. If the interior cleaning is included, this is sometimes referred to as a full-service gross lease.
The last category of leases are called Net Leases. These are leases where the tenant is responsible for the costs of owning real estate. In a NNN Lease (Net Net Net lease, also called a triple net lease), the tenant would pay the base rent and also be responsible for all of the interior and exterior maintenance, real estate taxes, insurance, utilities and any other expense, just as if they owned the building. In a true NNN lease the tenant would even be responsible for the roof and outer walls of the building, although we often see the landlord pay these expenses, especially in older buildings, and still call the lease NNN. The three “Net” expenses in NNN are usually referencing Taxes, Insurance & Common Area Maintenance (referred to as CAM). Some leases will be NN leases and the tenant pays taxes and insurance and the landlord includes the CAM. A single net lease would be where the tenant pays the taxes and landlord pays the insurance and CAM.
Even if a tenant is told what type of lease it is, they should carefully look at all of the terms to determine exactly what expenses they will be responsible for paying. A good real estate agent will be able to quantify all of the extra expenses in a lease so a tenant can compare different lease spaces on similar terms. This is usually done by adding estimated expenses to modified gross leases and net leases so the tenant can look at each property as if the lease were a gross lease. This will give the tenant a picture of the true cost of occupancy and a reasonable expectation of how much cash they will need each month to pay all of the rent.
To further complicate the comparison, the tenant should analyze the value of addition concessions that the landlord may be willing to include. These may include a period of free or reduced rent during the lease term or a build out allowance for tenant improvements (TI).
This same analysis can be used in reverse for a buyer consider purchasing a building that is leased. The buyer, or their real estate agent, must determine what the landlord is responsible for paying in the lease and deduct these expenses to determine the base rent amount. The base rent is the amount the landlord gets to keep or use for expenses like paying his mortgage. A good analysis will also look at the Effective Rent that the landlord receives over the lease term. Effective rent is the base rent minus the cost of free or reduced rent and tenant build-outs, annualized over the term of the lease. This may be an even better measure of the rent the owner can expect to receive in the future.
Once a tenant is familiar with the different types of leases, he will be able to compare different spaces on an ‘apples to apples’ basis. He will also realize that one space may seem much less expensive when looking at the advertised rate, but it might not be, when he knows what additional expenses to look for.
Dan Stiebel, CCIM