Commercial Lease Types Explained
Last Updated on December 13, 2023 by Morgan Beard
Commercial leases are agreements between landlords and tenants for the rental of commercial properties. There are several commercial lease types, and it is important for both landlords and tenants to understand the different types to make informed decisions. In this article, we will explain the main types of commercial leases and their advantages and disadvantages.
Gross Leases
A gross lease, also known as a full-service lease, is one of the most common type of commercial lease. In this type of lease, the landlord is responsible for paying all or most of the property operating expenses, such as utility costs, electricity costs, property taxes, and common area maintenance costs. Gross leases are common in commercial office space and can simplify billing for tenants.
One advantage of this type of lease is the landlord is responsible for most of the operating costs, which makes budgeting for tenant expenses easier. Essentially, all expenses associated with building maintenance and janitorial expenses fall in the Homeowners court. However, this commercial lease type can lead to higher base rents for tenants.
Modified Gross Lease
A modified gross lease is a leasing arrangement that falls between a full gross lease and a net lease. It aims to strike a balance between the needs of the landlord and tenant. Essentially, the lease is similar to a full gross lease, with one key difference: the commercial tenant is responsible for any increases in the building’s operational costs during the lease period that go beyond the fees calculated in the base year of the contract. This allows for greater cost flexibility and customization to meet the unique needs of both parties. However, it is important to carefully review the terms of the contract to understand which expenses are the responsibility of each party.
Triple Net (NNN) Lease
A triple net lease (NNN) is a type of commercial lease where the tenant pays for all building costs, even unexpected ones. It’s similar to a triple net lease, but the tenant covers all maintenance costs, including the roof and structure. This absolute lease type is typically reserved for large, established business types with good credit, and in return for covering expenses, the tenant may get a better lease deal in a great location.
Net Leases
A net lease is a type of commercial real estate lease that has the tenant paying some or all of the expenses in addition to the base rent amount. The expenses can include the building’s property taxes, property insurance, real estate taxes, and common area charges. There are three types of net leases: single net lease, double net lease, and triple net lease.
Single net lease – the tenant is responsible for paying property taxes, in addition to the base rent. The landlord usually pays for the other operating expenses like building insurance and maintenance costs. This type of lease is most commonly used for multi-tenant buildings, where the landlord does not have the ability to allocate maintenance fees or various building expenses to specific tenants.
Double net lease – the tenant is responsible for paying property taxes and insurance, in addition to the base rent. The landlord usually pays for the maintenance costs. This type of lease is most commonly used for stand-alone buildings or buildings with only a few tenants.
Triple net lease – is the most common type of net lease. In a triple net lease, the tenant is responsible for paying property taxes, insurance, and maintenance costs, in addition to the base rent. The landlord is not responsible for any operating expenses. This type of lease is most commonly used for single-tenant buildings or properties where the tenant has control over the maintenance and operation of the property. The one caveat with triple net
Net leases are advantageous for landlords because they transfer the risk of rising operating expenses to the tenant. They are also beneficial for tenants because they offer more control over the property and can result in lower base rent. However, tenants must carefully review the lease terms to ensure that they are not responsible for unexpected expenses and that the lease agreement aligns with their business goals.
Percentage Leases
A percentage rent lease is a type of commercial lease commonly used in retail spaces. In this type of lease, the tenant pays a base rent in addition to a percentage of their gross business sales. The percentage paid is usually negotiated between the landlord and the tenant and can vary based on the industry and the specific property.
This type of lease is beneficial for both the landlord and the tenant. For the landlord, a percentage lease can provide a share in the tenant’s success and higher profits from increased rent payments. For the tenant, it can help align their lease payments with their business’s financial performance and monthly sales numbers.
Variable Leases
A variable lease can change based on certain conditions and has two types: index and graduated leases. An index lease ties the rent amount to an index, like the Consumer Price Index or local rental market. For example, a tenant in a city may get yearly rent reviews based on city office rent.
A graduated lease increases rent according to a pre-determined schedule, such as yearly increases of 3% or seasonal rates. Seasonal businesses might pay more rent in busy times and less in slow times.
Ground Leases
A ground lease is a type of commercial lease where the tenant leases only the land and is responsible for constructing and maintaining any commercial buildings or improvements on the property. This type of lease is commonly used for long-term investments in real estate, such as shopping centers, industrial parks, or office buildings.
A ground lease can be beneficial for both the landlord and the tenant. For the landlord, it provides a long-term income stream without the need to finance the construction of buildings or improvements on the property. For the tenant, a ground lease can provide a lower cost of entry and greater flexibility in building and customizing their space.
Subleases
A sublease is a lease agreement between a tenant and a sub-tenant. The original tenant becomes the sub-landlord, and the sub-tenant pays rent to them, rather than directly to the landlord. Subleases can be beneficial for tenants who need to vacate their space before the end of their lease term.
A sublease can be a good option for tenants who want to avoid breaking their lease agreement, which could result in penalties or damage to their credit score. However, tenants should carefully review their original lease agreement to ensure they have the right to sublease and that they follow the proper procedures to avoid any legal issues.
Understanding Commercial Lease Types
There are several types of commercial leases that landlords and tenants can enter into, each with its own advantages and disadvantages. The financial responsibility and legal commitments associated with rental obligations of a lease have foundational business ramifications for both the property owner and the lessee. It is important for both parties to carefully consider their needs and goals before entering into a lease agreement, as it can have a significant impact on their business operations and financials.
