In the world of Commercial Real Estate, there are really two types of leases: Gross, meaning all inclusive, and net (sometimes called triple net or NNN), meaning broken down. There are pros and cons to both types of leases, and reasons people may prefer either one.
Gross leases are the simplest form of lease, this is where tenants pay their rent (typically a price per square foot), utilities (water and electricity), and that’s it. Typically, this is also a more expensive base rent, but because it leaves the expenses completely up to the Landlord, Tenants are paying for convenience.
TRIPLE NET LEASES
The most common type of lease nowadays is a somewhat more difficult to understand type called a Triple Net Lease (NNN). These use budgets to estimate the costs for the Owner/Landlord and seek to distribute these costs fairly to the tenants. In a fully leased shopping center for example, Owners/Landlords should have minimal operating expenses (or OpEx), because each tenant pays their proportionate share of the center’s OpEx. One difficulty here is that budgets are an estimate, based on reality, but the struggle comes during the first year when there are not previous years to use as support.
- Protect the owner from market fluctuations. Two of the 3 ‘Nets’, Property Tax and Insurance, are uncontrollable, with the third ‘Net’, Operating Expense, somewhat controllable based on the rates Landlords or Management Companies negotiate with vendors. If the prices change, the tenants cover the increase. In a gross lease, the owner covers this expense.
- Provide clarity to tenants for how their Common Area Maintenance (CAM) is being spent – tenants receive a breakdown of the three ‘Nets’, rather than one whole CAM rate or even more difficult, just paying a higher rent to make up for increases. This allows tenants to understand that for example the Property Tax or the Insurance was more expensive this year than last, causing their unexpected expense.
- Act as a pass through – expenses for property tax, insurance, and operating expenses should not be expenses for the ownership for a fully-leased center. Rather, these are spread out among the tenants proportionately depending on each tenant’s share of building square footage (according to the leases). At the same time, they are a “pass through” because they are also not income for Ownership – they simply offset costs for doing business.
- Run the risk of reconciliation – annually, property managers run a reconciliation report for operating expenses for the previous year. If the budgeted amounts that the tenants paid was lower than the actual amount paid, tenants will be invoiced for the difference. However, if actual costs were lower, tenants receive a refund! This actually turns what could have been a CON into a PRO. I won’t lie to you: expenses add up over time, and a year of expenses is difficult to estimate perfectly. This means that depending on the language in the lease, tenants could experience a yearly reconciliation. But tune in for a different article on lease language – that’s too large of a topic to just touch on here.
Now, I’m trying something new this time, curious on your thoughts for these visuals. Do you like them? Do they help with digesting the dense information above? Comment below – and tell me if you have any experience with leases like these!