One of the most frequently asked questions we receive is “What is a gross lease vs. a triple net lease?”
Clients ask us how each of them comes into play when determining the monthly and annual cost of rent. It is an important topic because both of these lease structures differ when it comes to the accounting for operating expenses (property taxes, insurance, and maintenance) of your office building. Here we will discuss and shed some light on Gross Leases versus Triple Net Leases and how they come into play in your commercial lease agreement.
The Gross Lease
Lease rates in this method are typically quoted as one figure that describes the dollar amount per square foot per year you will pay for your space (e.g. $25 Gross). This figure includes a base amount and also has operating expenses included in to the full amount. More importantly, under this method the landlord incurs the cost of your operating expenses for the first year (known as a base year) and uses that amount to compare operating expenses for tenants for the remainder of their lease term. As a means for landlords to defend themselves from extra expenses as a result of higher operating expenses they will create what is called a “base year expense stop”, which describes the point at which the landlord is no longer responsible for paying operating expenses and the tenant will take on the excess amount. For example, if in the first year of your lease the operating expenses were $5,500 and the second year of your lease they were $6,500 you as a tenant would be responsible for paying an additional $1,000 in rent for the year because the base year amount is set at $5,500. Additionally, the base year also remains if operating expenses go down over years, meaning that if first year expenses were $5,500 and second year expenses are $5,000 you as a tenant still pay $5,500.
The Triple Net (NNN) Lease
In a triple net lease each tenant is responsible for paying their base rent plus their pro-rata share of operating expenses for the building. This differentiation gives the triple net lease two separate components (base rent and operating expenses). For example, where a gross lease would be quoted as $25 per sf/yr, the triple net lease would be represented as a base rate of $15 per sf/yr plus operating expenses of $10 per sf/yr. Unlike the gross lease, in a triple net lease the tenant (not the landlord) is responsible for paying their operating expenses and the variances of them for each year of their lease term. This means that if they go up over years tenants will pay more for operating expenses and if they go down over years tenants will pay less. However, a lease negotiation tactic known as a “cap” or “ceiling” for operating expenses is commonly used to protect tenants from dramatic increases in operating expenses. This expense cap holds the tenant liable for operating expenses up to a certain level, at which any amount over the cap is incurred by the landlord. For example, if the tenant has an expense cap at $5,500 and the operating expenses were $6,500 the landlord is responsible for paying the additional $1,000 in operating expenses.
Jennifer Smith is a highly skilled commercial real estate advisor in Austin, TX for businesses seeking office, retail, warehouse, or medical space.