Net Lease vs. Gross Lease: What’s the Difference?

Ready to lease a space for your business? Being prepared is key to negotiating the best deal. Before you sign on the dotted line, take the time to understand the key terms you’re likely to encounter in your contract, plus the difference between a net lease vs. gross lease, so your lawyer and commercial real estate agent can help you reach an agreement that sets you and your business on the path to success

. First Things First: Understanding Base Rent

Whether you’re negotiating a net lease vs. a gross lease, everything starts with your base rent. Expressed as a formula: Base rent = Rentable square footage X Rental rate Before we examine the factors leading to increased rental rates, it’s important to understand that landlords often roll a building’s common spaces into the estimate of each tenant’s rentable square footage. So, for example, if the actual, usable square footage of the space you want to lease is 1,000 square feet, the rentable square footage – if it includes a portion of the building’s lobby, rooftop, halls and elevator space – could be as much as 1,500 square feet or more. The additional square footage charge, also known as a “core charge,” can add considerable bulk to your base rent, so tenants need to determine whether core charges are included in their base rent from the get-go. While the rentable square footage of a space is more or less fixed, the rental rate can fluctuate up or down based on a variety of factors, including:

The location of the building

The location of a property is one of the most critical factors contributing to its market value and rental rate. Commercial buildings located in areas home to an important demographic or target market that guarantee high auto and foot traffic and come with easy access to transit will generally have higher rental rates and, hence, higher base rents. In a post-pandemic world, however, the rise of remote or hybrid work has caused some metropolitan spaces to lose a portion of their market value. As a result, suburban buildings that can better attract and service remote workers closer to home could see their increased market value reflected in higher base rents.

Annual operating expenses

Utilities, taxes, maintenance, insurance, property management, marketing, and administration costs all contribute to a building’s annual operating expenses. The higher these costs, the higher the base rent needed to recoup them.

Mortgage rates

Although tenants don’t usually have visibility into the mortgage rate paid by their landlord, in general, the higher the landlord’s mortgage rate, the higher the base rent.

The size of the building

The larger the building, the steeper its property taxes and operating costs, so the higher the base rent.

The condition of the building

Recently renovated buildings featuring updated HVAC systems or those with new roofing or flooring will look to recoup these capital expenses with a higher base rent.

The newness of a building

In general, the newer the building, the higher the base rent.

What Is a Gross Lease?

A gross or full-service lease is one in which a business tenant pays a landlord a flat monthly or annual rental fee to occupy a commercial space, with the understanding that the landlord will be responsible for covering all operating expenses associated with it, including utilities, insurance, property taxes, maintenance, etc. With only one fixed lease payment to worry about each month, business tenants can budget better and focus on winning contracts or making sales instead of attending to the paperwork, and cash outlays that go along with taking on operational expenses. But while tenants may find gross leases convenient because landlords define what operating costs to include in a tenant’s base rent figure, gross leases are likely to incorporate expenses a tenant usually wouldn’t be responsible for, such as the landlord’s marketing, administration, property management, landscaping and even legal bills. And because most landlords won’t settle for simply breaking even on a property, a hefty markup for profit will be levied on it all. Gross leases are standard on commercial properties such as office buildings or retail spaces housing multiple tenants.

What Is a Net Lease?

There are three types of net leases: single net leases (N), double net leases (NN) and triple net leases (NNN). In each case, the tenant pays base rent plus one or more costs associated with the commercial property they want to lease.

Single Net (aka Net) Leases

A single net lease requires tenants to pay base rent plus some (or all) of the annual property tax on the building or space, while the remainder of the operating costs remain the landlord’s responsibility.

Double Net (aka Net-Net) Leases

With a double net lease, tenants pay base rent plus property taxes and insurance for the space or building they occupy.

Triple Net (aka Net-Net-Net) Leases

Triple net leases start with base rent, then add property taxes, insurance and most of the costs of operating the building – including all building repairs and maintenance – to tenants’ monthly bills. Because tenants are willing to take on various additional expenses associated with the space, landlords usually reduce the base rent associated with a net lease, negotiate extended lease terms of ten to fifteen years, and may even allow tenants to transfer their lease should they decide to move. Net leases are common for stand-alone office buildings and warehouses, as well as retail spaces associated with fast-food restaurants, convenience stores, gas stations and big box outlets. Tenants who prefer a net lease vs. gross lease often cite longer lease terms, reduced base rent, increased transparency regarding operating costs and the additional savings they can realize by decreasing expenses associated with utilities and maintenance as the main reasons for their choice.

Occupying the Middle Ground With a Modified Gross Lease

In a modified gross lease, both the tenant and the landlord agree to pay a portion of the ongoing expenses associated with a commercial real estate property. Tenants often pay base rent plus utilities, insurance and property taxes, while all other costs, including property maintenance and repairs, are covered by a landlord. In some modified gross leases, tenants pay only base rent plus utilities for their first year, then add a pro-rated share of the building’s operating costs afterward. For example, after year one, a tenant occupying 25 per cent of a building would be responsible for base rent, utilities and 25% of the building’s operating costs.

Net Lease vs. Gross Lease: Which is Best?

Whether you choose a net lease vs. gross depends on many factors, including what makes the most sense for your business once you and your accountant run the numbers. Rounding out your lease review team with a lawyer who specializes in lease negotiations and a commercial real estate agent who knows the local market can help you weigh the pros and cons of your landlord’s initial offer, negotiate better terms going forward and create a final contract that best serves you and your business.

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