Types and Basics of Commercial Leases
Commercial leases are different from residential leases and have more variety than residential ones. The main features that distinguish commercial leases from residential leases can be listed as follows:
You can negotiate all the terms of the lease.
Unlike residential lease they generally have much longer terms.
A commercial lease agreement outlines the responsibilities of both landlord and tenant, which vary widely from one type of lease to another. Who will be responsible for paying property taxes and insurance? Who will pay for utilities? Who will cover maintenance and repairs expenses? The type of lease you choose is of great importance in determining your responsibilities, and you can make a better evaluation when you know how each one works.
There are seven different types of commercial leases with sub-types. Although the outlines of all commercial lease types are explained below, it should be kept in mind that each contract to be made is unique and each provision should be carefully evaluated.
1. Gross Lease/Full-Service Lease
Tenants pays base rent and utilities.
Landlord pays all building expenses, including maintenance costs, insurance, and real estate taxes.
Tenant may pay for additional expenses after the base year.
This type is mostly preferred for the properties occupied by multiple tenants, like office buildings.
A full-service lease (also known as a gross lease), is commonly used for commercial properties such as office buildings.
According to this type agreement, the tenant pays base rent and utilities while the landlord pays for all building expenses, including maintenance, taxes, insurance, repairs, and other costs. The tenant only has to make one payment each month and the landlord takes care of everything else. Due to its simplicity, a full-service lease is ideal for tenants. They can predict exactly what their expenses are going to be and not have unexpected expenses.
The disadvantage of this type of agreement for tenants is that they’re completely dependent on the landlord when something needs to get fixed.
Beside that, in these leases, landlord takes the risks into consideration such as major repair or a sudden increase in maintenance costs, as they take all responsibility for the building. As a result of having all the responsibility on the landlord, the base rent is usually higher than that of other types of leases.
Sometimes, a full-service lease agreement may have a stipulation limiting the amount a landlord is required to pay. If the expenses exceed that amount, the tenant will be responsible for paying them.
Similarly, a full-service lease agreement may have that cap the amount the landlord will cover in operational expenses after the base year. The base year is the first year of occupation and generally sets the base rent amount for the following years.
2. Net Lease
A net lease is a type of commercial property lease. In this agreement, the base rent paid by the tenant is lower than that of a full-service lease, but the tenant also pays other expenses. These expenses can include common area maintenance items (CAMS), insurance, and property taxes.
In these type agreement, to calculate tenant’s pro-rata share of operating expenses, landlord takes the total operating cost per square foot for all rented space then divide it among tenants based on the percentage of the building used by each tenant.
There are three different types of net leases. The landlord passes a different level of financial obligation onto the tenant in each type of net lease.
Triple-Net Lease (or NNN lease)— A triple net lease is basically the opposite of a gross lease. The tenant pays rent, utilities, in addition to a proportionate share of CAMS, real estate taxes, and property insurance. CAMS generally include janitorial services, property management fees, sewer, water, trash collection, landscaping, parking lots, and any other commonly shared area or service. The landlord pays is a base amount of building maintenance and repairs. NNN leases are often longer-term. This type of agreement can cause issues for tenants when maintenance fees are far higher than expected.
Tenants pay rent and utilities and their pro-rata share of all of the building’s operating expenses, including maintenance fees, building insurance, and property taxes.
Landlord pays base building maintenance and repairs.
This commercial lease type is very common.
Double-Net Lease (or NN lease)— The tenant pays rent, utilities, property taxes, and the cost of building insurance. The landlord is only responsible for maintenance costs. Like other net leases, base rent is generally lower since the tenant is responsible for additional expenses.
Tenant pays rent and utilities plus property taxes and building insurance.
Landlord only pays maintenance costs.
This is another most popular commercial lease type.
Single-Net Lease (or N lease)— The tenant pays base rent, utilities, and the property tax. The landlord pays the building insurance and maintenance fees.
Tenant pays rent, utilities, and property taxes.
Landlord pays building insurance and maintenance.
3. Modified Gross Lease
Tenant pays base rent, plus a portion of operating costs.
Landlord pays the other portion of operating costs.
Parties' obligations determine by negotiation.
It is very highly common.
Modified gross leases is a combination of a net lease and a gross lease. It’s similar to a gross lease in that a base rent, utilities and a portion of operating costs, as one lump sum, are paid by the tenant, the landlord pays the rest of the operational costs.
However, the exact payment amount is negotiated by parties. The tenant's payment could include any or all of the three nets.
It is highly preferred because it has the simplicity of a gross lease but has the flexibility to determine the responsibilities of the landlord and tenant. In fact, most commercial leases could fall under this category, as both the landlord and tenant pay some of the operating expenses.
4. Absolute NNN Lease/Bondable Lease
Tenants pays all building expenses.
Landlord does not have any responsibility for building costs.
These leases are the least common type.
An absolute triple-net lease (also known as a bondable lease) is the exact opposite of a gross lease, and it is more binding than a standard triple-net lease.
The terms absolute NNN lease and triple net lease are sometimes used interchangeably, but they are not the same. In a triple net lease, the tenant usually pays a for some or all building’s maintenance and repair expenses, but sometimes the landlord pays some part of those expenses.
However, In An absolute triple-net lease, the tenant is responsible for all expenses associated with the property including any structure or roof repairs. The tenant takes all responsibility for all the costs no matter what happens, even in the event that the building were to be destroyed due to a natural disaster. In this case, the tenant would, on the one hand, pay the costs for the reconstruction of the building, and on the other hand, would continue to pay the rent.
Although the base rent for this lease is much lower than other types of leases, this is the rarest commercial lease type. Most tenants don't want to take on this level of risk.
5. Percentage Lease
Tenant pays base rent, and a specified percentage of gross income, which is usually around 7 percent.
Landlord pays some or all of the property taxes, insurance, and maintenance fees.
It is common to use for retail space.
These types of leases are typically used with retail spaces such as restaurants and retail stores in malls and shopping centers. In this agreement, the tenant pays base rent and a specified percentage of their gross income, which is usually around 7 percent. The landlord pays some or all of the maintenance costs, insurance, and property taxes.
A percentage lease differs from the rest because the company’s success determines how much the tenant will pay. Usually, these agreements start with a base rent, and the tenant begin to pay the percent amount after reaching a certain level of income called the “breakpoint.”
To offer lower base rent is the one of the advantages of this lease since the tenant pays a percentage of his income. The other advantage is that the landlord is paid more if the tenant could get higher income.
