Types of Commercial Leases

Unlike residential leases, not all commercial leases look the same. Understanding how different types of leases work is necessary to evaluate commercial real estate, both as a landlord or a tenant.

You can categorize most commercial leases into three (3) main types:

• Gross Lease
• Net Lease
• Percentage Lease

Gross Lease

Essentially, a gross lease is where the tenant pays a single, all-inclusive monthly rent payment. The landlord is responsible for paying the operating expenses associated with the property, such as property taxes, maintenance costs, insurance, and utilities.

While the tenant isn't technically making a payment for the operating costs, the landlord will have factored these costs into the rent price. This is important to clarify when you're comparing rent prices of two different buildings side-by-side.

Gross leases are most common in office buildings. They're a convenient option for tenants who want a predictable monthly payment and don't want to deal with managing property-related expenses.

Nevertheless, it's important for both landlords and tenants to carefully review the terms of the lease agreement to make sure that they understand who is responsible for what costs, as there can be some variations in how gross leases are structured.

Net Lease

In a net lease, the tenant is responsible for paying some or all of the property's operating expenses - in addition to their base rent payment.

These expenses include things like property taxes, maintenance costs, insurance, and utilities. The specific expenses that the tenant is responsible for paying can vary depending on the type of net lease that is agreed upon.

There are a few different types of net leases, they can be loosely broken down into single net leases, double net leases, and triple net leases.

In a single net lease, the tenant is responsible for paying property taxes in addition to their base rent payment.

In a double net lease, the tenant is responsible for paying property taxes and insurance premiums, in addition to their base rent payment.

And in a triple net lease, the tenant is responsible for paying property taxes, insurance premiums, and maintenance costs, in addition to their base rent payment.

Net leases are often used in commercial real estate settings where the tenant is occupying a larger space, such as a retail centers and plazas. They can be a good option for tenants who want more control over the property's operating expenses and are willing to take on some additional financial responsibility.

Again, it's important for both landlords and tenants to carefully review the terms of the lease carefully as there is no standard structure on how these types of leases delegate responsibility.

Percentage Lease

A percentage lease is typically only used in shopping malls settings. It's the least common of the three (3) lease types.

In a percentage lease, the tenant pays a base rent amount, but they also pay a percentage of their gross sales as rent to the landlord.

The percentage of gross sales can vary depending on the terms of the lease agreement, but typically in the 5-10% range. In some instances the percentage will be a fixed amount and in others it may increase or decrease based on the tenant's sales performance.

Percentage leases work because they align the business interest of the landlord and tenant. The tenant benefits from lower fixed costs as they establish their customer base or have seasonal downtimes. The landlord benefits directly from the tenant's financial success, and in-turn, is incentivized to upkeep the property and drive more foot traffic to the shopping center.

Of course, it's necessary to have clear provisions on how gross sales are recorded, calculated, and verified. This should be detailed in the lease agreement.

Summary

• Gross lease is where the tenant pays a single rent fee, and the landlord covers all operational expenses.
• Net lease is where the tenant pays all or some of the operational expenses for the property, including taxes, maintenance, insurance, and utilities.
• Percentage lease is where the tenant pays a base rent, plus a gross percentage of their sales. This aligns both party's interests.
• Remember, these terms for commercial lease agreements are not official or standardized. So, even if someone tells you that it's a "_____" type of lease, it's necessary to have a professional review and verify the rights and responsibilities on your behalf.