Commercial Real Estate Leases

Gross vs. Net Agreements

Commercial real estate leases typically fall into one of two major categories: gross or net leases. The two are distinctively different, and one may be more preferable than the other for your business, depending on the age, condition, and costs associated with the leased property.

Under a gross lease, the lessor (landlord) assumes responsibility for all the property maintenance, insurance, and taxes. The lessee (renter) pays a fixed amount of rent that includes those services and costs. These types of leases are most common in multi-tenant properties such as office buildings, industrial parks, and some retail properties.

One advantage of this type of lease for the lessee is that a gross lease fixes the cost to rent the property at a set rate. Sometimes a lessor may offer a modified gross lease, which has a passthrough provision that allows the lessor to pass along property cost increases, such as higher taxes or insurance, to the lessee.

A modified gross lease may stipulate that the lessee pays a base rate for the rent that includes costs for the first year. After the first year, the lessee then agrees to pay a portion of any increased property costs, such as taxes, repairs, improvements, or utilities. The amount is typically based on the percentage of the property allocated to the lessee, and it may be billed as an annual charge or on a monthly basis.

A net lease differs from a gross lease in that the lessee agrees to pay all or some of the costs associated with the property, such as taxes, insurance, and maintenance. With this type of lease, the costs are not fixed. With a net lease, the lessee can expect to pay lower rent in exchange for paying some or all of the property’s costs, which can vary. A commercial real estate lease that stipulates the lessee pays the taxes, insurance, and maintenance costs is known as a triple net lease.

A triple net lease almost always favors the lessor over the lessee because the lessee cannot rely on fixed costs. For older properties, a triple net lease can pose a financial risk because large expenses can be incurred if major repairs, such as a roof replacement, come into play. If the lessee is launching a business in a new building, where maintenance, taxes, and insurance can be expected to remain stable for some time, such a net lease does offer some advantages.

In keeping with the law of supply and demand, a lessee may have more leverage to pursue a gross lease or more favorable terms in a modified lease if the demand for commercial property is slow. Keep in mind that no matter what terms are used—gross, net, triple net, or modified—it is advised that the lease be scrutinized by an attorney experienced in commercial leases so that the lessee fully understands the rent amount, the term length of the lease, and what, if any other costs, are to be paid or shared by the lessee.