Three Primary Types of Commercial Property Leases

What are the Three Primary Types of Commercial Property Leases?

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A commercial lease is a legally binding agreement between a landlord and a business tenant for the use of a property for business purposes. Unlike residential leases, commercial leases are highly negotiable and can vary significantly in their structure and financial implications. These leases typically have longer terms, more complex provisions, and fewer consumer protections compared to residential leases. Understanding the intricacies of a commercial lease is crucial for any business before signing, as it forms a cornerstone of their operational success.

So, what are the three primary types of commercial property leases? They are: Gross Leases, Net Leases (which include Single, Double, and Triple Net variations), and Percentage Leases. Let’s explore each one.

What is a Gross Lease (Full-Service Lease)?

A Gross Lease, also known as a Full-Service Lease, is often considered the simplest type for tenants from an administrative perspective. In a Gross Lease, the tenant pays a fixed, all-inclusive monthly rent amount. The landlord is then responsible for paying most or all of the property’s operating expenses.

What’s Included?

Typically, a Gross Lease covers the following expenses:

  • Property Taxes: The annual taxes levied on the property by the local government.
  • Property Insurance: Insurance covering the building and common areas against damage or liability.
  • Common Area Maintenance (CAM): Costs associated with maintaining shared spaces like lobbies, hallways, parking lots, and landscaping.
  • Utilities: In some cases, utilities like water, electricity, and gas may be included, although this is less common.
  • Repairs and Maintenance of the building.

Pros for Tenants:

  • Predictable Monthly Rent: The fixed rent makes budgeting straightforward and predictable.
  • Simplified Budgeting: Tenants don’t have to worry about fluctuating operating expenses.
  • Less Administrative Burden: The landlord handles the payment of most bills related to the property.
  • Landlord Responsibility: The landlord is responsible for managing and maintaining the property.

Cons for Tenants:

  • Higher Base Rent: The base rent in a Gross Lease is typically higher than in a Net Lease to account for the landlord’s assumption of operating expenses.
  • Less Control Over Expenses: Tenants have limited control over how the property is managed and the associated costs.
  • Expense Stops: Some Gross Leases include “expense stops,” which means the tenant may be responsible for paying a portion of operating expenses that exceed a predetermined threshold.

Example Scenarios:

Gross Leases are commonly used for:

  • Office spaces in multi-tenant buildings.
  • Situations where tenants prefer a predictable and hassle-free arrangement.
  • Businesses that want to focus on their core operations rather than property management.

What is a Net Lease (Single, Double, and Triple Net Leases)?

Net Leases represent a shift in financial responsibility from the landlord to the tenant. In a Net Lease, the tenant pays a lower base rent but is also responsible for paying a portion of the property’s operating expenses. There are three main variations of Net Leases, each with increasing levels of tenant responsibility:

Single Net Lease (N Lease)

In a Single Net Lease, the tenant pays the base rent plus one major operating expense: property taxes. The landlord remains responsible for all other expenses.

Example: A small business leases a retail space with a Single Net Lease. They pay a monthly base rent of $2,000 plus their share of the annual property taxes, which might amount to an additional $300 per month.

Double Net Lease (NN Lease)

In a Double Net Lease, the tenant pays the base rent plus two major operating expenses: property taxes and property insurance. The landlord is responsible for maintenance and other costs.

Example: A restaurant leases a space with a Double Net Lease. They pay a monthly base rent of $3,000, plus their share of property taxes (say, $400/month) and property insurance (say, $200/month), for a total monthly payment of $3,600.

Triple Net Lease (NNN Lease)

The Triple Net Lease (NNN Lease) is the most common type of Net Lease. In this arrangement, the tenant pays the base rent plus all three major operating expenses: property taxes, property insurance, and common area maintenance (CAM) charges. In many NNN leases, the tenant is also responsible for repairs and maintenance of their individual unit, sometimes including structural elements.

CAM Charges Explained: CAM charges cover the costs of maintaining the shared areas of a property, including:

  • Parking lot maintenance and repair
  • Landscaping
  • Security
  • Lighting
  • Hallway cleaning
  • HVAC system maintenance for common areas
  • Property management fees

Example: A large retail store leases a space in a shopping center with a Triple Net Lease. They pay a base rent of $5,000 per month, plus their share of property taxes ($600/month), property insurance ($300/month), and CAM charges ($800/month), for a total monthly payment of $6,700. They are also responsible for any repairs or maintenance needed within their store.

Pros for Tenants (Net Leases Generally):

  • Lower Base Rent: The base rent is typically lower than in a Gross Lease, reflecting the tenant’s assumption of operating expenses.
  • Greater Control: Tenants may have more control over certain expenses, particularly in a NNN lease where they manage maintenance.
  • Potential for Cost Savings: If the tenant manages the property efficiently, they may be able to reduce operating expenses and save money.

Cons for Tenants (Net Leases Generally):

  • Variable Expenses: Operating expenses can fluctuate, making budgeting less predictable.
  • Increased Administrative Burden: Tenants are responsible for managing and paying multiple expense categories.
  • Potential for Unexpected Costs: Unexpected repairs or increases in property taxes or insurance can significantly impact the tenant’s expenses.
  • Responsibility for Repairs: In NNN leases, tenants take on more responsibility for repairs.

What is a Percentage Lease?

A Percentage Lease is a unique type of lease commonly used in retail settings, particularly in shopping malls and high-traffic areas. In a Percentage Lease, the tenant pays a base rent plus a percentage of their gross sales revenue above a predetermined threshold, known as the “breakpoint.”

Base Rent + Percentage:

The structure typically involves a relatively low base rent, which provides the landlord with a minimum guaranteed income. On top of this, the tenant pays a percentage of their gross sales, typically ranging from 1% to 10%, depending on the industry, location, and negotiation.

When It’s Used:

Percentage Leases are most often used for:

  • Retail stores in shopping malls and shopping centers.
  • Restaurants in high-traffic locations.
  • Businesses where sales volume is directly related to the location’s desirability.

Pros for Tenants:

  • Lower Rent During Slow Periods: If sales are below the breakpoint, the tenant only pays the base rent, providing a buffer during slow seasons or startup phases.
  • Aligned Incentives: The landlord and tenant share a common interest in the success of the business. The landlord is motivated to maintain a thriving shopping environment to drive traffic and increase sales.

Cons for Tenants:

  • Higher Rent During Peak Periods: When sales are strong, the tenant pays a higher overall rent.
  • Sales Reporting Requirements: Tenants must accurately track and report their gross sales to the landlord, which can be an administrative burden.
  • Potential for Audit: Landlords often have the right to audit the tenant’s sales records to ensure accuracy.

Breakpoint:

The breakpoint is a crucial element of a percentage lease. It’s the sales threshold above which the percentage rent kicks in. There are two main types of breakpoints:

  • Natural Breakpoint: This is calculated by dividing the base rent by the agreed-upon percentage. For example, if the base rent is $2,000 per month and the percentage is 5%, the natural breakpoint is $40,000 ($2,000 / 0.05). The tenant would pay 5% of all gross sales above $40,000 per month.
  • Artificial Breakpoint: This is a negotiated breakpoint that is not directly tied to the base rent and percentage. It might be set higher or lower than the natural breakpoint, depending on the bargaining power of the landlord and tenant.

Find the Right Commercial Lease and Protect Your Business Interests with Garmo & Garmo

At Garmo & Garmo, we understand that selecting the right commercial lease is a critical decision that can significantly impact your business’s financial health and operational efficiency. We can guide you through the fundamental differences between Gross Leases, Net Leases (Single, Double, and Triple Net), and Percentage Leases, empowering you to make an informed choice tailored to your specific business needs. Our team of experts will thoroughly review lease agreements, negotiate favorable terms, and leverage our network of real estate attorneys and brokers to protect your business interests.

Contact us today to learn more about how we can help you navigate the complexities of commercial leasing and negotiate the right lease for your business.