What you need to know about ....Leases

Today’s focus is on types of leases…and let me tell you there are dozens!

Full service, gross, modified gross, NNN, NN, ground lease…there are many variations.  Today we will talk about the most popular current forms of lease.

Leases have developed over time from verbal, or even handshake agreements, to documents that can exceed 100 pages.  Today’s leases are legal documents and should be reviewed by experienced legal counsel prior to being signed (that is my disclaimer. Get used to it, it will probably pop up every week).

Warning:  I will use the words “typically” and “usually” a lot in this blog but every lease is different.

Full Service Lease:  Typically a full service lease would be found in an office building.  Its name says it all…Full Service.  The building landlord provides all services to the tenant for the price of the rent.  This includes: utilities, janitorial service, property taxes, trash removal, building insurance etc…There are some building that also provide telephone service and cable TV but they are the exception rather than the rule.  In these leases the landlord is also responsible for repairs to the building or the tenant’s space, like the HVAC system, replacing light bulbs or repairing roof leaks.  

Important to note: These leases typically have a “Base Year” or “Expense Stop”.  This is meant to protect the landlord from increases in operating expenses (the cost of janitorial, utilities, insurance etc…).  Example, if Joe is leasing space in a new Knoxville building  for $20.00psf per year his Base Year/Expense Stop would be around $6.00psf per year.  The $6.00 is the amount the landlord had budgeting for operating expenses the year the lease is signed.  At the end of the year the landlord reconciles all their operating expenses.  If the operating expenses exceed $6.00psf Joe has to pay the landlord the difference. If it ends up at $6.04psf Joe has to write a check for $0.04psf.   This is a standard practice in Knoxville real estate.

Gross Lease:   Probably the most common of commercial leases, although less common in new, Class-A buildings.   A gross lease is very similar to a full service lease because the landlord still provides all the services needed for the tenant, only without a Base Year/Expense Stop.   Instead of a Base Year/Expense Stop typically there is a larger than standard annual increase in lease rent rates.

 These leases are popular for a variety of reasons:

1. It makes accounting for the landlord much easier
2. The tenant doesn’t have to worry about writing an extra check at the end of the year.

Some would say both the landlord and tenant are taking chances with this type of lease.  For the landlord the risk is greater, if operating expenses go up significantly (such as the building being reassessed for tax purposes) the increase in lease rent rate may not cover the difference.  For the tenant, there is a chance that they will pay slightly more for rent than is needed, but in this age of rising costs it’s probably a safe play.

Both Gross and Full Service leases typically require high levels of property management to make sure the properties and tenants are serviced correctly and that the end or year accounting is properly calculated.

Modified Gross Lease:  Just like it says, it’s a gross lease with slight modifications.  The rent the tenant pays will cover most operating expenses but the tenant will be responsible for one or more of the operating costs, usually janitorial service or utilities. In most cases the landlord is still responsible for repairs in the office space.

NNN or NN Lease:  These are known as “triple-net” leases and are usually found in retail or industrial leases.  The N’s stand for common area maintenance (or CAM), property taxes and building insurance.  For reasons of simplicity these are referred to as CAM.

The precise items that are to be paid by the tenant are specified in the lease. For properties that are leased by more than one tenant, such as a shopping center, the expenses that are “passed through” to the tenants are usually prorated among the tenants based on the size (square footage) of the area occupied by each tenant.

In most NNN, the landlord is responsible for the building and the common areas.  They repair the roof, structural problems, sidewalks and parking lot.  The tenant is responsible for any internal repairs like plumbing, replacing lights or HVAC repairs. 

The difference between a NNN and NN lease is the common area maintenance is not included (usually).  This is common in industrial property and single tenant buildings like a restaurant or other retailer no in a shopping center.  Single tenant buildings can also have an “Absolute Net” lease.  This means they pay the landlord rent and also are responsible for all upkeep of the building, landscaping, property taxes and insurance.       

Ground Lease:  Just like it says, the tenant is leasing the ground.  The most common on these are found with drug stores like CVS and Walgreens.   These companies lease the land for 10 to 50 years, build a building and operate their business.  They write a check to the landlord every month, or every year.  That is all there is to the landlord/tenant relationship.  At the end of the lease the tenant can leave the building or tear it down, depending on what the lease says.  The tenant is responsible for all aspects of the building, the land and any repair that is required.  

As you can see the variations in leases can be immense and some what confusing.  If you are looking around and have questions contact a commercial broker (such as Justin Cazana at Cushman & Wakefield|Cornerstone CRES; jcazaan@cornerstonecres.com).  Brokers can walk you through the details you need to make your lease work for you.

Justin Cazana, CCIM