Commercial real estate has a variety of lease types; each variation has their merits. I’ll summarize three common types of leases you’ll see when negotiating with commercial tenants. It’s important to note, that several variations of each lease type can be negotiated, and you should always hire an attorney to review before signing
Absolute Triple Net Leases NNN
A true triple net lease is very simple. The tenant pays for all expenses of the property, utilities, repairs, even property taxes. The three N’s represent taxes, building insurance, and maintenance. In addition to the base rent, the tenant will pay for each of these items in full. Aside from having the tenants pay for virtually all expenses, one of the greatest benefits of NNN leases are that the landlord is protected against expense inflation, as it relates to the asset; when taxes, insurance, utility bills, or even the cost of labor in construction/handyman work, the landlord isn’t affected since these expenses are absorbed by the tenant.
NNN leases are common in retail with freestanding buildings such as Family Dollar, Dollar General, Starbucks, CVS, Walgreens, and other well-known companies. Typically, but not always, the capitalization rates on NNN leases are lower. There are some exceptions.
Many times, buildings that have multiple tenants, charge a common area maintenance fee, also known as CAM fees. These fees are negotiated up front and charged based on the tenant’s pro rata share of the building.
There are single and double net leases as well. N leases (single net) the tenant is generally responsible for paying the property taxes.
NN leases (double net) the tenant is generally responsible for the property tax and building insurance.
Modified Gross Leases
Modified gross leases can vary from property to property. Similar to a NNN lease, the tenants typically pay a proportionate share on the building insurance, taxes, and some maintenance. Though, unlike in a NNN lease, the landlord will arrange care for the building and grounds. In a NNN lease, the tenant would organized landscaping, building maintenance programs, etc. Some landlords prefer this type of arrangement as they have more control over the maintenance program and can ensure the building is well kept.
Gross leases, the landlord pays for all the operating expenses. This type of agreement is not common in commercial real estate. There are a few exceptions, like shared office spaces, where tenants rent individual offices out of a single suit. Sometimes, special circumstances call of a gross lease, and a landlord may oblige the tenant, who prefers a flat fee for budgeting purposes. Gross leases are mostly used on smaller commercial buildings.
Overall, which lease to use, depends on the type of building and tenant you have. I own buildings that have each of these agreements in place. Each have their pros and cons and I can’t say I have a preference of the type of lease I like to use the most. My most profitable building has multiple tenants under gross leases; it’s also the most management intensive. Having the right lease in place is one of the most important aspects to owning commercial investment real estate. Prior to becoming a full-time investor, and opening a real estate investment fund, I was a commercial real estate agent and had the opportunity to help lease numerous properties. Although, I no longer sell or lease real estate for anyone other than my investment company I want to stress again, it’s very important to hire a professional who understands how to negotiate and write these types of leases. Good luck!
Haydn Zeis - Principal
Lonicera Management, LLC