Gross Lease vs Triple Net on Small Biz Leases

[Adam G.]

I wanted to throw this question out to see what other people are doing on leases. 

I have office / warehouse space 1500sf to 5000sf. I'm finding so many small business LOVE to have a gross lease so they are absolutely sure of their total expense. At the size biz I'm renting to it seems they have trouble grasping the NNN sometimes.

My question is this...am I playing russian roulette by not doing triple net leases and offering a gross lease? Over the last few years it's worked out rather well but I wanted to see what other people are doing.

[Daniel Chang]

@Adam G.

I also own industrial/flex smaller units. I just simply do a base rent + HVAC maintenance fee (since each unit has its own HVAC unit). HVAC repairs are passed through to tenants. Tenants pay their own utilities. Even though my standard MG leases have a CAM provision that include base year taxes/insurance and tenants pay increases as well as maintenance, landscaping, etc., I actually strike this out! The way I have it setup, it's so much easier for potential tenants to understand. If they understand it, and they know their future costs are more controlled, they are more comfortable in signing. There is less negotiation, less back/forth and I get quicker rents (think opportunity costs). It especially helps that my local competitors have NNN setup. Now of course, my base rent is higher than my local competitors. But my building is 100% leased and has been for last 2 years (since I took over). Similar buildings locally pretty much all have some vacancies. Yet if you do the math, the effective rent is about the same (again, think opportunity costs from vacancies)

1) I agree with you in that the smaller users tend to be small mom/pop businesses and hence they don't quite understand NNN.

2) From a pure headache standpoint, if they don't understand it, then you will spend a lot of time/effort trying to collect more rent if expenses go up.  Your tenants will of course put up a fight.

3) From an administrative standpoint, it's much more complicated to keep track of each tenant's annual reconciliation and base year expenses (I manage the property myself).  You WILL eventually have a tenant who wants to see your books and prove the expenses and how you calculate them.  

NNN is much better if you have a property manager or you are an absentee owner, as you have less control over expenses. NNN is safer if the tenant wishes to sign a longer term lease. With MG, you can actually do better by controlling costs. Just over the past year, I found several new vendors that provide great service but with less expense and thereby increasing my NOI. The difference between NNN and MG in reality is small, since you have to look at the effective market rent regardless. If property taxes go up for instance, I will be raising my asking rent.

Another thing to think about: I intend to hold onto my properties long term and care mostly about cash flow. However, if you are looking to sell soon, then that's a different strategy, as buy and hold investors like to have longer term NNN type leases and you will likely get a higher selling price.