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There are two ways a landlord can rent out a commercial property. He can either ask that the tenant pay just for the space of the estate and all other expenses such as taxes, utilities and insurance are paid by him as an extra expense. Or he can request that the tenant pay for the space and all other expenses are included within the rental agreement which is called a Commercial Gross Lease.
Key Points:
- Get into the details - The more you know the more profitable your decision will be
- Research and then more research
- Be patient and seek guidance
If it’s capital for your commercial real estate investment you’re after, see our recommendation: Commercial Real Estate Loans.
4 things you need to know about gross commercial leases
1. Gross lease real estate term lengths
The term length of a gross lease can vary from three to five years or shorter. This lease agreement is typically shorter than usual lease lengths, as the landlord takes on much of the risk. It is not uncommon to draft a 12- or 18-month term length for a gross lease.
2. Lease amount and lease increases
It is important to assess the lease amount. It is advisable to consider rates for similar spaces. If you discover that the lease rate is too high, consider lowering your asking price. If you receive many inquiries, you may want to consider increasing your rate.
Commercial landlords typically add an annual rent increase into the lease terms. You may want to consider this when deciding how to invest in commercial real estate. It is also important to note that rent and lease are distinct, as rent generally means a monthly contract.
3. Property alterations
Property owners need to consider modifying or customizing areas for tenants using a design-build or build-to-suit contract. If you ask for a sizable sum of rent for your market, you might want to allow for property alterations at no extra cost and request that the tenants sign an extended lease agreement.
4. Subleases
Decide whether or not you wish to offer tenants the possibility to sublease their space to a different business company. This term is useful in less fierce markets. Sometimes a tenant might be considering a replacement tenant that is happy to complete the final stages of the lease. When allowing for subleases, there are legal matters to consider, so make sure you consider these terms carefully if you permit them.
The pros and cons of a commercial gross lease
Here are the pros and cons of types of commercial leases:
Pros of a gross lease
This kind of lease tends to favor the tenant as it assures that there will be no unexpected expenses. This way, the tenant can budget appropriately. The tenant only needs to focus on the base rent.
Tenants favor a gross lease as it lets them attend to running their company without focusing on the building’s state. The benefit for you as a landlord is that you can probably charge a greater per-square-foot rate as the rent is all-inclusive.
Cons of a gross lease
This type of lease demands that the landlord be more attentive, as they are entirely responsible for the upkeeping of the physical state of the building and it's associated systems. This lease is not the best possible situation for a commercial property owner seeking a passive investment. A solution could be for the property owner to hire a property manager.
Certain tenants might not favor a gross lease as they have minimal influence over the general appearance of the building and no say over when maintenance is done. They could also be subject to greater rent than with different kinds of commercial leases.
Gross lease vs net lease
A gross lease is an agreement where the tenant's rent payments are paid gross to the landlord. The landlord must deduct all operating costs from the gross rent amount, leaving the landlord with the net operating income received from the property.
Here are key attributes you should know about gross leases:
- Most residential leases are gross leases
- Tenants pay a monthly sum to the landlord
- The landlord deducts insurance, taxes, and other operating costs
- The landlord accepts the risk of any changes in the operating cost
The landlord must charge a high enough rental amount to factor in any increases in operating costs, maintaining the expected net operating income for the property.
Net leases explained
A net lease is a lease where the tenant's net minimum rent (or basic rent) is paid in net to the landlord. The tenant must also pay a part of all operating costs. The basic rent forms the landlord's net operating income, and the extra rent covers the property's operating costs.
Here are key attributes you should know about net leases:
- Most commercial leases are net leases
- Net leases often require the tenant to pay as installments and monthly in advance, an approximate of the year's operating costs as extra rent
- The landlord expects to receive basic rent plus the extra rent
- The tenant accepts the risk of any changes in the operating cost throughout the lease
Triple net vs gross lease: what’s the difference?
Here are the three kinds of net leases:
- Single net lease - the tenant must pay rent and property taxes
- Double net lease - the tenant must pay rent and insurance, and property taxes
- Triple net lease (NNN) - the tenant must pay rent and insurance, maintenance, and property taxes
Tenants might have greater sway over certain costs and elements of the property. However, they also assume more responsibility. For example, if the tenant pays maintenance costs, they might make superficial modifications. But they also incur repair costs.
Landlords typically limit or prevent superficial modifications to the property, even if the tenant pays the maintenance expenses. Tenants must also pay utility bills.
Frequently Asked Questions (FAQs)
What Is the Difference Between a Lease and Rent?
A contract agreement is created between a lessee and a property owner with a lease. The landlord consents to provide the tenant with complete access to the property. Rent is a payment amount charged by the property owner, providing the tenant with sole use of the property.
What Are the Main Types of Commercial Leases?
The most common kinds of commercial leases are net and gross leases. The categories are fully serviced gross leases, modified gross leases, triple net leases, double net leases, and single net leases.
What Is the Most Common Type of Commercial Lease?
The gross lease is the simplest and most common kind of lease. It is a contract agreement between a tenant and a landlord. The lessee agrees to pay the lessor a fixed amount of money for a specified period in exchange for the sole use of a property. This sum of money includes the rent and every cost connected with ownership, including insurance, utilities, and taxes.
What is net operating income?
Net operating income (NOI) is a sum used to calculate the profitability of income-producing real estate investments. NOI can be calculated by deducting all necessary operating expenses from all revenue made by the property.
To Sum Up
There are different types of commercial leases. The gross commercial lease is commonly used in single-tenant and multi-tenant office buildings, some retail properties, and industrial properties. Read any lease contract carefully before you sign, and seek out the assistance of a lawyer or accountant when needed. Such specialists can also show you how to value commercial real estate.
Many individuals renting out their commercial properties begin their investment journey with a commercial real estate loan. Such loans can provide potential commercial real estate investors with the momentum to get started in the field.
Lendio is a business financing platform that functions as an all-in-one shop for financing. Lendio allows you to compare various commercial real estate loans in one place.
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