Everything You Need to Know About Commercial Real Estate Leases

[Tyler Kastelberg]

Listening to experts talk about commercial real estate leases is like listening to someone speaking in code. You understand the individual words, but the terms have some special meaning that is impossible to decipher, unless you know the code.

Think of this post as your codebook. Here, you’ll find everything you need to know about commercial leases. Remember, that even though many of these terms, like triple net lease, have widely accepted meanings, you always need to carefully review a lease agreement to verify that everyone is operating under the same set of definitions.

Triple Net Lease (NNN)

Triple net leases, like all net leases, allow the landlord to charge a lower base rent. The Landlord then passes on a series of expenses related to the operation and maintenance of the building to each of the tenants on a pro-rata basis.

Triple net leases are also known as net—net—net leases or as NNN leases.

In a triple net lease, the tenant pays all three of the “nets”:

• 1.Property taxes
• 2.Insurance on the building
• 3.Common area and maintenance costs

If a tenant was renting 1,000 square feet in a 10,000 square-foot commercial building under a triple net lease, they would pay their base rent and would pay 10% of the building costs, or nets.

Triple net leases are the most popular leases for free-standing commercial buildings with a single tenant. Triple net leases can be found with industrial properties and some retail spaces. But, they are widely used in all areas of commercial real estate. All net leases generally favor landlord interests.

Absolute Lease

The absolute lease or absolute triple net lease, is much less common than the standard triple net lease. It is much more stringent. In an absolute lease, the tenant caries every risk imaginable, including construction expenses, rebuilding costs from catastrophes and having to pay rent even if the building is condemned.

The absolute lease is only used with single-tenant buildings where the tenant is a large enough company to self-insure or carry their own insurance to hedge against these risks.

Real estate investors often prefer these leases because it makes the property easier to manage and the leases easier to sell.

Double Net Lease (NN)

A double net lease, also known as a net-net lease or a NN lease, is similar to a triple net lease. The landlord charges a lower base rent in exchange for the tenant carrying a percentage of the costs for operating and maintaining the building.

In a traditional double net lease, tenants pay:

• 1.Property taxes
• 2.Insurance on the building

The landlord is responsible for the common area and maintenance costs.

Double net leases are most often used for industrial tenants and some retail tenants.

Single Net Lease (N)

Single net lease, also known as a net lease or N lease, is rarely used. AS you would expect, it is similar to the other types of net leases except the tenant is paying a base rent, and a single “net”, usually the property taxes.

However, there are many variations of the single net lease. Some singe net leases pass on the insurance or maintenance costs instead of the property taxes.

Single net leases, when they are used at all, are used with industrial tenants.

Full Service Lease or Gross Lease (FSG)

A full service is the opposite of a net lease. A full service lease is also known as a gross lease, full service gross lease, or FSG lease. These leases tend to be more favorable to the tenants than the net leases are.

In a full service lease, the landlord bears all the costs of property taxes, insurance, the common areas and maintenance. The tenant pays a higher rent but does not pay anything else.

The exact terms of each full service lease will be different. Often the tenants will still be required to pay for janitorial services for the areas under their sole control. Many leases will also have a provision capping the amount of utilities costs that the landlord will be responsible for. Tenants that use a large amount of electricity may find that they have to pay for their excess use beyond the cap established in the agreement.

Full service leases are most often used for office space, some industrial and retail leases.

Modified Gross Lease

The modified gross lease, sometimes called a modified net lease, is considered to be a compromise between the triple net lease and the full service lease. In a modified gross lease, the tenants still pay a single lump sum rent to the landlord. However, the landlord and tenant negotiate which of the “nets” are included as part of the rent.

Most often, these leases do not include electricity or janitorial. The tenants are responsible for making arrangements for these services.

Modified gross leases are most commonly used in office space properties, but they are also sometimes used with industrial and retail tenants as well.

Percentage Lease

The percentage lease has two main components. The tenant pays a base rent and also pays a percentage of sales to the landlord.

Typically, these leases have what’s known as a breakpoint. Before the tenant’s sales reach the breakpoint, they only pay the base rent. After sales reach the breakpoint, they begin paying a percentage of the sales and the base rent.

The landlord will usually be responsible for the “nets”. A percentage lease is usually only used in retail leases, such as shopping centers and malls. The tenants like the low fixed costs. The landlords enjoy an upside if they do a good job bringing in foot traffic for their tenants.

The percentage gives landlords and tenants a common incentive to succeed.

Sometimes percentage leases will also have strict requirements for the tenants that cover store operating hours, signage, and what days the store can be closed. The landlord may be able to fine the tenant if they fail to open on time or choose not to be open on a day the lease stipulates the store must be open (Thanksgiving for example).