Lease Rent Terms Vary And Need An Equalizer
You’re looking at commercial leases for the perfect space and it’s time to talk seriously about your lease rate agreement. If you’re new to commercial real estate, it helps if you know what you’re getting into. Even better: use a commercial office broker specializing in leasing to integrate the best software tools into a process that can help balance and optimize your decision.
Here’s a closer look at the two most common commercial lease types. The best software balances the various aspects of rent, step-ups, inflation provisions, tenant improvements (TI), building common area maintenance costs (CAM), etc. given every scenario and time frame. “Time is of the essence in office leasing”™ says Bruce Fogelson of chicagoofficebroker.com early and often.
The short term is not always the best in consideration of an office lease. Amortizing improvements over time, discounting the values into a net present value of a decision, inflation, renewals, expansions, and even contractions in space are just part of the decision nexus. And the times are changing!
It is important to understand the types of lease and their terminology to understand the language of office leasing. The following are a few of the basic terms.
Gross Lease/Full-Service Lease
A gross lease, or full-service lease, is the simplest type of commercial real estate lease. The landlord is responsible for the entirety of the property’s operating expenses, including those related to occupancy: property taxes, maintenance and utilities. The tenant simply pays a base rent amount. Compared to other commercial lease types a gross lease typically has higher rent payments. In this case the landlord takes the risk of inflation and higher taxes.
Key Takeaway for Tenants: Despite the higher rent payment, this lease is often preferred by tenants because of its simplicity: it’s easy to understand, reduces bookkeeping complexity and is quick to negotiate. Gross lease tenants don’t need to dive into the details of the commercial real estate process and can maintain focus on their core business operations and profit objectives, instead of lease management activities.
Escalation clauses may be included in a gross, or any lease, to account for cost flexibility (tax increases, variable operating expenses, utilities for heat and A/C or higher insurance rates). Many gross leases include or exclude some of these variable costs and a good office broker negotiates these from one building to another, providing clients with an apples-to-apples evaluation that makes leasing decisions more transparent and effective. Note, rental rates are just one factor of occupancy cost. Space differs in square footage and utility. Rent is not the only factor.
Any type of lease rate may have a step-up in rent. In a gross rent this is a predictable way of accounting for inflation for both landlord or tenant. Some step rent can be tied to an index.
Modified Gross
There may be additional language that allows rent increases over a base rate of expenses to offset variable costs that grow from the time of the original lease. This MODIFIED GROSS rent is where base rent plus current and particular costs are tossed in together. Those costs can be any, all or more than the above.
Once again, it’s important for your broker to “normalize” these costs and many assumptions, in order to compare and forecast occupancy costs. This is where advanced software is a key asset and delivers the most value, in combination with a knowledgeable broker’s input of assumptions.
These additions to the standard gross lease agreement can usually be negotiated but keep cost variability in mind when deciding if a gross lease is the right commercial lease for your organization. In one or the other case, the tenant or landlord takes the risk of variable costs other than just base rent. A broker using the best analytic software provides the best analysis, including adjustments for inflation and Net Present Value and thus offers the opportunity to make the most informed decisions.
Net Lease
The tenant pays a “net” rent and, according to the specific type of net lease, is also responsible for property taxes, insurance and/or maintenance, and potentially more. Precise definitions are:
- Single Net Lease (N Lease) defines monthly payments as rent plus a negotiable portion of the property tax.
- Double Net Lease (NN Lease) requires the tenant be responsible for both property taxes and insurance premiums.
- Triple Net Lease (NNN Lease) goes one further: the tenant is responsible for property taxes, insurance premiums and maintenance fees.
Key Takeaway for Tenants: Triple net leases are preferred by many landlords and property owners and are among the most common for some types of commercial leases available. If you choose a net lease as a tenant, you do have the ability to review the property owner’s operating expenses, with the potential to negotiate adjustments in your favor. Once again, your office leasing broker will look into cost history and expectations.
However, always remember whether the lower rent in these agreements is more favorable than other types depends on what your other payment responsibilities are. Your broker can use software to evaluate these and any types and assumptions over time and provide you with the extra data needed to make the best decision.
Final Takeaway for Tenants: A modified gross lease (discussed above) is typically viewed as a happy medium that offers more room to negotiate and fine tune costs, if you don’t mind the added complexity required for evaluation. But that’s where a good broker will fill in the blanks and provide you the insights required to make the best decision.
Jameson Commercial Real Estate commands the software to evaluate any type of lease, and variations, side-by-side. The commercial office brokers at Jameson also have access to the numbers associated with any building choice and terms. Taking the tenants goals and budget into consideration helps shape the analysis but math is the great equalizer. Having flexibility and confidence in the numbers frees up the tenant to focus on the many qualitative aspects that influence the best solution for each tenant.
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