4 Critical Commercial Leases to Know
Real estate professionals do more than sell properties and represent buyers. Many are involved in leasing and renting, helping landlords manage their buildings, or being landlords themselves. Therefore, it's crucial for current and future real estate agents to understand the different types of leases used in the industry.
There are four main types of leases: net lease, percentage lease, variable lease, and gross lease. Let's explore each one, along with some examples to help clarify.
1. Net Lease
A net lease requires the tenant to pay a portion or all of the property expenses, including taxes, insurance, and maintenance, in addition to the base rent. There are four variations:
Single Net Lease: The tenant pays rent and property taxes.
Example: A small retail shop renting a space where the tenant pays $2,500 per month in rent plus annual property taxes of $6,000.
Double Net Lease: The tenant pays rent, property taxes, and insurance.
Example: An office tenant paying $3,500 per month in rent, $7,000 in property taxes, and $2,500 in building insurance annually.
Triple Net Lease (NNN): The tenant covers all operating expenses, making it the most common net lease.
Example: A restaurant tenant paying $4,500 per month in rent, plus property taxes, insurance, and maintenance costs totaling $15,000 annually.
Absolute Net Lease: The tenant assumes all property expenses, including major repairs.
Example: A large retail chain leasing a building for $12,000 per month and covering all expenses, including a $60,000 roof repair.
This type of lease shifts some financial responsibility and risk to the tenant, making it favorable for landlords.
2. Percentage Lease
A percentage lease involves a tenant paying a base rent plus a percentage of their gross sales, commonly used in retail spaces. This type of lease benefits both parties: tenants have lower base rents, and landlords receive a share of successful business revenues.
Example: A clothing store in a mall pays $2,500 per month in base rent plus 8% of gross sales over $60,000. If the store makes $90,000 in a month, the tenant pays an additional $2,400 ($90,000 - $60,000 = $30,000 * 8%).
This type of lease is common in shopping centers and malls, providing landlords with income that scales with tenant success.
3. Variable Lease
A variable lease adjusts according to specific conditions, and there are two main types:
Index Lease: The rent is tied to an economic index, usually the Consumer Price Index (CPI), allowing rent to adjust with inflation or other market conditions.
Example: An office lease starts at $6,000 per month, adjusting annually based on the CPI. If the CPI increases by 2%, the new rent is $6,120 per month.
Graduated Lease: Rent increases at predetermined intervals, often annually. This is useful for businesses expecting growth.
Example: A tech startup signs a lease for $3,500 per month, with a 3% annual increase. In the second year, the rent is $3,605 per month.
These leases are helpful for tenants anticipating business growth and landlords looking for predictable income increases.
4. Gross Lease
In a gross lease, the tenant pays a fixed amount of rent, and the landlord covers most or all property expenses, such as taxes, insurance, and maintenance. There are two subtypes:
Full-Service Lease: The landlord covers all expenses, providing simplicity for the tenant.
Example: A law firm leases office space for $8,000 per month, with the landlord covering all utilities, taxes, and maintenance.
Modified Gross Lease: Costs are shared, with specific expenses negotiated between the landlord and tenant.
Example: A marketing agency pays $5,500 per month in base rent and shares utility costs with the landlord, who covers taxes and insurance.
These leases offer simplicity and predictability for tenants, while landlords handle operational expenses.
Final Thoughts
Understanding the four main types of commercial leases—net lease, percentage lease, variable lease, and gross lease—is crucial for real estate professionals.
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TL:DR: Real estate professionals must understand the four main types of commercial leases: net, percentage, variable, and gross leases. Each lease has unique financial responsibilities and benefits for both tenants and landlords. Examples of these leases help clarify how they function in various property types, making it essential knowledge for current and aspiring real estate agents.