What is a Full Service Gross Lease?
All commercial real estate properties have tenants with leases, but not all leases are created equal. Understanding the difference between lease types is critically important for understanding how much income a commercial real estate property generates and the costs that are needed to run it.
Broadly, there are two major commercial real estate lease types, “Gross” and “Net.” The key difference between the two is who is responsible for paying the property’s operating expenses.
In order to understand how each of these lease types work, it is first necessary to understand how “operating expenses” are defined.
What Are Operating Expenses?
Operating expenses are the costs necessary to run a commercial property on a day to day basis. Typically, they include categories like: property taxes, property insurance, landscaping, utilities, common area maintenance, and any other costs associated with the general upkeep of the property. These costs must be paid and the lease agreement defines who is responsible for paying them.
What is a Full Service Gross Lease?
In a Full Service Gross Lease, the tenant is responsible for paying one monthly rental amount while the landlord pays for all of the operating expenses. While this may work well from a simplicity perspective, it also exposes the landlord to the risk of rising operating costs. For this reason, they may elect to work with a “Modified” Gross Lease Structure.
Full Service Lease vs. Modified Gross Lease
A Modified Gross Lease structure seeks to solve for the risk of rising operating costs by passing some portion of them through to the tenant. Which costs are passed through are specified in individual leases, but they typically include things like utilities and janitorial services. In a multi-tenant property, the expenses are allocated based on each tenant’s pro rata share of square footage occupied (e.g. expenses are charged per square foot of occupancy).
From a tenant standpoint, this structure shifts some of the risk of rising operating costs from the landlord to themselves, which they may not like. As such, the landlord may include a feature in a modified gross lease known as an “expense stop.” If this clause exists, the landlord will pay the operating expenses in the first year of the lease (the “base year”) and this amount that acts as a “stop” for the tenant. In future years, the landlord is responsible for any additional expenses over the stop.
Often, the full service gross lease structure is compared with another popular lease structure known as a “Net” lease.
Full Service Gross Lease vs. Net Lease
A Net lease is the complete opposite of a Full Service Gross Lease. In this structure, the tenant pays a lower base monthly rental amount, but they are also responsible for some portion of the property’s operating expenses. This may sound very similar to a modified gross lease, but the difference lies in which expenses the tenant is responsible for and how much. There are four net lease types that are used in commercial real estate properties:
- Single Net Lease: Tenant pays base monthly rent plus one of the major operating expense categories – usually taxes.
- Double Net Lease: In a double net lease, the tenant pays base monthly rent plus two of the major expense categories – taxes and insurance.
- Triple Net Lease: Tenant pays base monthly rent plus three of the major expense categories – taxes, insurance, and maintenance.
- Absolute Net Lease: Tenant pays base rent plus all operating and maintenance costs for the property.
Of the four types, the triple net lease – sometimes referred to as an NNN Lease – is particularly popular with both tenants and investors. Tenants like it because it gives them control over how the property is run. Investors also like them because the tenant is in control and it drastically reduces the amount of time and effort they have to devote to managing the asset.
Pros and Cons of a Full Service Gross Lease
When considering the utility of a Full Service Gross lease, it is important to understand the pros and cons from both the tenant and real estate investor perspective.
Advantages of a Full Service Gross Lease
For the landlord, the key advantage of a Full Service Gross Lease is simplicity. The just receive one monthly rent payment and use it to pay for the property’s operating expenses. For accounting purposes, it is easier to track. In addition, the monthly rent payments tend to be higher with a full service gross lease so the landlord has the potential to generate higher income.
Tenants also benefit from the simplicity of a full service gross lease by only having to make one monthly rent payment. But, more importantly, they are not exposed to the risk of higher operating costs. If property taxes go up significantly in a given year, the tenant’s rent does not go up because the landlord is responsible for paying for this cost.
Disadvantages of a Full Service Gross Lease
For the property owner, the disadvantage of a full service gross lease is that they are exposed to the risk of rising operating costs. Using the example above, if real estate taxes/building expenses rise significantly in a given year, they must be paid, which reduces the amount of net income the landlord receives from lease payments.
For the tenant, the major disadvantage of a full service gross lease is that they are more expensive. In order to protect against the risk of rising operating costs, property owners ask for a higher lease rate. In some cases, a tenant may end up paying more for a full service gross lease than they would have with other types of commercial real estate leases.
Conclusions & Summary
A Full Service Gross Lease is a commercial real estate lease type that requires the tenant to make one monthly rental payment and the landlord to pay all of the property’s operating expenses. As a subset of this lease type, a Modified Gross Lease requires the tenant to pay monthly rent plus some portion of the operating expenses that are specified in the lease agreement.
For both the landlord and tenant, the major advantage of a full service gross lease is simplicity. There is only one payment to track for accounting purposes. However, this structure also exposes the landlord to rising operating costs and they can be more expensive for the tenant in the long run.
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