Understanding Commercial Real Estate Leases

One of the most important aspects of managing commercial real estate includes understanding leases. There are a variety of leases employed by landlords to manage their tenants, and it is necessary whether you are leasing or renting a commercial space that you completely understand the agreement (lease) that you are signing.

A lease is like a partnership. It outlines how the business relationship between the lessor and the leasee will proceed. Following are some types of commercial leases that you, as an investor, may encounter.

The Triple Net Lease (which is abbreviated as “NNN” in advertising) is used extensively in commercial real estate. It is popular for multi-tenant and single-tenant industrial and retail properties.

The three elements—the “triple”—are Taxes, Insurance, and Operating Expenses. In a true NNN lease (and many so-called NNN leases are not “true” NNN), the tenant pays a basic rent to the landlord, and in addition pays ALL the operating costs of the property: the real estate taxes, all the insurance premiums, and all the operating expenses—from utilities to maintenance contracts, pest control to security. The tenant is responsible for everything under this form of commercial real estate lease.

In a single-tenant building, many if not all of these costs will be directly paid by the tenant. Even the tax bill will be invoiced to the tenant. In a multi-tenant building, it is more common for the landlord to be invoiced for at least some of the operating expenses (taxes and insurance at least) that will be collected, often monthly, from each tenant according to their pro-rated share. This separate collection is often called “CAM,” for Common Area Maintenance (although it may include non-maintenance items such as insurance and real estate taxes).

A Gross lease, sometimes identified as a Full Service Lease, in its pure form has the tenant paying a single flat sum each period to the landlord as the total rent, with the landlord responsible for all costs of operation of the property. A one-night stay at a hotel is such a lease, as are some short apartment leases.

More often, Gross leases should be called Modified Gross, because under their terms a tenant will be required to pay some of the operating costs (electricity, water, cleaning, for example), and/or the rent each year may increase by the amount that the operating costs—or the tenant's share of them—have increased in the previous year.

Like anything else in real estate, it is important that you understand the agreements and the terms before entering into a deal. Understanding commercial leases isn’t as difficult as performing brain surgery, but you need to do a little homework all the same.