Lease Basics 101
Written by Darren McCorkle
One of the most important aspects of commercial real estate for anyone looking to lease space to understand is the difference between “Gross” and “Net” Leases. At its most fundamental, Gross and Net Lease structures deal with the apportionment of responsibility for the taxes and insurance, maintenance, utilities, and other costs associated with the operation of the property. You can think of these as being on a spectrum, with a Net Lease being on the side of greater tenant cost responsibility and a Gross Lease being on the side of greater landlord cost responsibility.
The Gross Lease is perhaps the easier of the two to understand. The tenant simply owes the landlord a single dollar amount, as determined by the lease. The landlord then uses money from these proceeds to pay the expenses listed above. For the tenant this is the most predictable form of lease, as the rent payments are all predetermined. It does have more risks for the landlord however. Operating expenses have a way of increasing over time, and if the landlord misjudges what future expenses will cost, they could find themselves with eroding margins of profitability. As a result of this many landlords shy away from Gross Leases.
In a Net Lease the tenant’s rent is broken up into two components: a “base rent” component and an expense component. In this way the landlord “passes through” the costs of operation to the tenant. This expense component changes over time due to changes in the costs of operating the building – increases in property taxes, for instance – thus giving the landlord a measure of protection against operating expense increases over the long term. Most landlords adjust this expense component annually. It is important to note that Net Leases will generally be tuned to the market in such a way that the two amounts will, when added, be competitive with Gross Leases on similar buildings.
Because of the large number of moving pieces, there are many variants of the Net Lease structure. By far the most common way, however, is called a “Triple Net”, or “NNN”, Lease. It is so called because under a NNN lease the tenant is responsible for the net taxes, net insurance, and net maintenance costs for the building. Under a Triple Net Lease the expense component is often just called “CAM”. Originally CAM stood for Common Area Maintenance, which is of course only one part of the expense component of a Net Lease. Over time, however, it has come to be used as a catchall term for all of these operating expenses.
Even though the different lease structures place the bulk of the responsibility more heavily on one party or the other, there are limits to the responsibilities on both sides. A Gross Lease for a single tenant building, for instance, might still contain a clause that obligates the tenant to make repairs to the HVAC should it break down. On the other hand even the most stringent Net Lease will still require the landlord to be responsible in the event of a catastrophic event (the building burning down, for instance).
It is always important to consider that these terms are often used rather loosely; always know exactly what you are getting when you enter into a lease. Take utilities, for instance. Even though it is not part of the definition of the Triple Net Lease, many landlords will include some or all of the utilities and still call it NNN. Does it include electric? How about water? Janitorial? These are all questions you should ask when comparing the CAM of different buildings. And finally in closing it is important to note that, even though the structures appear very different, the tenant will be paying for these expenses one way or another: either through a higher Gross Lease or a separate CAM component.
| Dougall McCorkle, MBA Sales Associate and Commercial Specialist Premier Commercial, Inc., Licensed Real Estate Brokers | Darren McCorkle Sales Associate and Commercial Specialist Premier Commercial, Inc., Licensed Real Estate Brokers Direct: 239.213.7223 Cell: 239.207.8668 darren@premiermail.net |