Understanding the Different Types of Commercial Leases
Commercial leases can be comprised of a variety of terms and industry jargon that can be confusing to someone who’s not experienced in commercial real estate. Net, triple net, gross, absolute net… how do you know which one is right for you when renting or investing?
There are two lease types that I commonly see in the Baton Rouge area, each with several sub-types that have slightly different terms. Below I will detail what they are and how they benefit both the landlord and tenant.
1) Net Lease: A net lease requires the tenant to pay some of the costs associated with the operation of the commercial property in addition to base rent. For many net lease sub-types, the tenant is responsible for its utilities.
a. Single Net Lease (Net Lease): The tenant is responsible for the base rent plus it’s pro-rata share of one of the “nets” (property taxes, insurance or common area maintenance). The landlord usually covers all other building expenses.
b. Double Net Lease (NN Lease): The tenant is responsible for the base rent plus it’s pro-rata share of property taxes AND property insurance. In this instance the landlord is still responsible for maintenance and repairs.
c. Triple Net Lease (NNN Lease): The tenant is responsible for their base rent plus all three “nets” – property taxes, insurance and common area maintenance.
d. Absolute Net Lease: In this lease type the tenant is responsible for all expenses, including the roof and structure. This is commonly seen with national tenants like McDonald’s, CVS / Walgreens, and similar uses.
In the Greater Baton Rouge area when dealing with retail properties, the most common lease structure is Triple Net (NNN). This is also the most advantageous for landlords. If you are an investor, you’ll prefer a NNN lease. Due to the fluctuating operating expenses it can be difficult for tenants to budget the true cost of a lease, so they should review their lease carefully with a commercial real estate advisor to fully understand fees and potential caps.
2) Gross Lease: Under a gross lease the tenant pays one flat fee. While this makes it easier for a tenant to budget, the landlord estimates operating expenses and builds them into a flat fee. This type of lease structure can be very advantageous for the tenant.
a. Modified Gross Lease: Like a net lease, in a modified gross lease the landlord and tenant agree to share some of the operating expenses. A modified gross lease often includes an expense stop, which means the landlord is responsible for all expenses up to a certain dollar amount, and any amount exceeding this limit is the tenant’s responsibility.
Gross leases are viewed as more favorable to the tenant than net leases because tenants know exactly what their monthly financial responsibility will be for the length of their lease term. The downside is that if a landlord overestimates the annual property expenses, the tenant may wind up paying a higher than necessary rate.
As a landlord or a tenant, it’s important to know and understand the different types of commercial leases and how the terms will impact your business. Reach out to a commercial real estate advisor in your area to discuss the lease type that is best for you.
Justin Langlois, CCIM is a Commercial Real Estate Investment Advisor with Stirling Properties servicing Baton Rouge, Louisiana and surrounding markets. Please reach out to Justin to discuss your real estate investment strategies.