A Lease That Suits You
In a commercial context, leases and lease terms can vary. However, there are three common types of leases used in commercial tenancies: (i) net lease; (ii) gross lease; and (iii) semi-gross lease. These three types of leases are mainly distinguished by the degree to which a tenant is responsible for the various expenses in relation to the property, as well as the risk allocation for any cost uncertainty with respect to the leased space.
This type of lease is commonly referred to as a ‘triple net lease’. The three nets referred to are property taxes, building insurance, and common area maintenance. This means that the tenant is responsible for each of the foregoing costs; and the landlord is not responsible for any of these. Additional expenses may also be included in the lease, offloaded by the landlord to the tenant. As such, any risk of cost uncertainty is generally borne by the tenant. A triple net lease is most advantageous to landlord as the three major expenses that are required to maintain a building (with or without tenant) are passed on to the tenants proportionately. Generally, the landlord only maintains responsibility for expenses related to structural repairs/replacements.
As this lease will typically benefit the landlord more than the tenant, it is very important for the tenant to not only review the lease thoroughly, but also understand their rights, liabilities, and obligations in detail.
Net leases are very common in retail and industrial properties, but less common in office buildings.
Under a gross lease, the tenant is only responsible for the rent per month, and generally, nothing more. The landlord and tenant agree on a price per month at the outset. As such, the risk of any cost change (e.g. change in property tax, utilities, or building insurance premiums) is borne by the landlord. Gross leases are typically used for older properties or by relatively small-scale landlords looking for simplicity. The leases generally have shorter lease terms, and are quite commonly used for office buildings.
For landlords entering into a long-term gross lease contract, it is important to take stock of and discuss any major expenses that property tax increase to protect themselves. Additionally, utilities are included in the rent; therefore, it is important for the landlord to take into consideration and plan ahead for any change in uses as utilities might rise over time.
This type of lease is sometimes referred to as a ‘modified gross lease’. In this type of lease, the landlord and tenant agree on the rent, utilities, and potentially additional expenses at the outset. This distinguishes the lease from a net lease, as the tenant is not responsible for any cost fluctuation, other than utilities. However, this is also not a gross lease, as the landlord and tenant have determined and built in some certainty as to the costs of utilities and additional expenses. In other words, this type of lease is a gross lease, but the tenant agrees to pay the utilities. The rent portion includes the operating costs, reducing the risk to the tenant for the changes in these costs. When using this type of lease, it is important for a landlord to take consideration for potential increases in operating costs, especially if entering into an agreement for a long term. There is no one correct type of lease: each situation will require a particular determination of cost certainty and risk allocation. Parties are strongly encouraged to discuss their objectives and enlist the services of an experienced professional when entering into and negotiating a new lease.
The content of this article is meant for informational purposes only. It is not meant to provide any financial, business, commercial, or legal advice. Readers are encouraged to discuss all matters with a commercial realtor or lawyer for all particular situations involving the content of this article.
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