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Commercial Real Estate Leases: Understanding Gross, Double Net, and Triple Net Leases
Understanding Commercial Real Estate Leases
A commercial real estate lease is an important and complex legal document and process with many factors to consider. One of the most important decisions a landlord or tenant will make is selecting the type of lease that best meets their needs. The three most common types of commercial real estate leases are gross, double net, and triple net.
What Is a Gross Lease?
A gross lease is the simplest form of commercial real estate lease. In a gross lease, the landlord is responsible for paying all operating expenses, including property taxes, insurance, and maintenance. The tenant pays a flat monthly rent, which covers all expenses associated with the property. Gross leases are commonly used in office or retail spaces, where the landlord wants to simplify the lease arrangement and the tenant wants the security of knowing their monthly rental rates will not change from month to month.
If you, as a property owner, wish to use gross leases for your building, be sure you comprehensively understand the costs of operating your property. This way, you can set a flat leasing rate that ensures you bring in at least enough revenue to cover your property taxes, insurance, maintenance costs, and more. Don't forget to consider your third-party management costs as well, if you utilize a commercial real estate property manager.
Gross leases are typically more expensive than any other type of lease, simply because of the extra costs an owner must cover out of the rental revenues. Despite the added cost for tenants, some tenants may prefer gross leases due to their fixed nature.
Let's look at an example of a 2,000-square-foot retail building below.
Square Feet | Rent | |
|---|---|---|
Tenant 1 | 500 | $5,000 |
Tenant 2 | 1,500 | $15,000 |
Total | 2,000 | $20,000 |
As you see, this property generates $20,000 in rental revenue. Now, let's look at the costs.
Cost | Amount |
|---|---|
Property Taxes | $1,100 |
Insurance | $2,000 |
Maintenance, property management | $3,200 |
Total | $6,300 |
The total expenses, which include everything from property taxes to the cost of managing the building, end up being $6,300 in our example. The owner of the property is solely responsible for covering these charges.
If the larger of the two tenants moves out, the revenue from the property would not be sufficient to cover its costs.
One thing to note is that gross leases aren't always truly flat. They may have escalating clauses to counter rising taxes, insurance premiums, or maintenance costs. It is important to fully understand escalating clauses and how that may affect rent in the future.
What Is a Double Net Lease (NN)?
In a double net lease, the tenant is responsible for paying a portion of the operating expenses in addition to their monthly rent. This typically includes property taxes and insurance. The landlord is still responsible for other expenses, including maintenance, repairs, and property management.
Double net leases are often used in industrial or warehouse spaces, where the landlord wants to reduce operating expenses and the tenant wants the security of a fixed monthly rent payment.
Rental rates are lower than in a gross lease, but once the other costs like taxes and insurance are added in, they may be comparable. See the same example above, but reworked as a NN lease. We'll assume the NN rate is 80% of the gross lease rate.
NN Rent | Property Tax (Pro rata) | Insurance (Pro rata) | Total Paid by Tenant | |
|---|---|---|---|---|
Tenant 1 | $4,000 | $275 | $500 | $4,775 |
Tenant 2 | $12,000 | $825 | $1,500 | $14,325 |
The total cost paid by each tenant is lower than for a gross lease in this scenario. However, it benefits the landlord to hedge against rising tax or insurance costs. If insurance costs go up in the next year, this will be covered fully by the tenants — it will not impact the landlord's bottom line (unless there is vacant space in the building).
Note that in a double-net lease, tenants typically pay the property taxes and insurance costs directly to the landlord, who then ensures that everything is paid on time and correctly.
What Is a Triple Net Lease (NNN)?
In a triple net lease, the tenant is responsible for paying all operating expenses in addition to their monthly rent. This includes property taxes and insurance, as in a double net lease, with the addition of nearly all costs associated with maintenance, repairs, and property management, often referred to as CAM, or common-area maintenance, costs.
Triple net leases are commonly used in freestanding retail or office buildings, where the landlord wants to minimize their expenses and the tenant wants the freedom to customize the property to their specific needs. They are also extremely common for large, single-tenant industrial properties, particularly those built to tenant specifications (for example, an Amazon fulfillment center or an IKEA warehouse).
A triple net lease not only reduces the financial burden but also transfers the financial risks from the landlord to the tenant. Should any of the three expenses (insurance, property tax or CAM) increase, then the landlord will not have to absorb the cost. NNN leasing rates are typically far lower than gross lease prices.
The table below highlights an example of a triple net lease, assuming the leasing rate is 60% of the gross lease price.
NNN Rent | Property Tax (Pro rata) | Insurance (Pro rata) | CAM Costs (Pro rata) | Total Paid by Tenant | |
|---|---|---|---|---|---|
Tenant 1 | $3,000 | $275 | $500 | $800 | $4,575 |
Tenant 2 | $9,000 | $825 | $1,500 | $2,400 | $13,725 |
In our examples, the triple-net lease option is the least expensive of the three types we've covered. With NNN leases, a landlord's income is lower — at least at the outset — but the benefit of this lease structure is that a property owner can accurately project an investment's profitability.
After all, taxes, insurance, and CAM costs generally will increase over time. With a triple net lease structure, these increases don't affect the owner, as the tenants bear all the costs.
Note that triple net leases don't absolve an owner of all expenses. Some costs that owners generally need to cover, even under a NNN lease, include:
- Major upgrades or improvements to the property
- Structural repairs (replacing a roof, fixing foundation problems)
- Leasehold improvements (generally covered in tenant improvement allowances)
What is the difference between a triple net (NNN), double net (NN) and gross lease in commercial real estate?
The main difference between a triple net (NNN), double net (NN) and gross lease in commercial real estate is the amount of financial responsibility the tenant has. A gross lease stipulates that the tenant is only responsible for paying rent, while a double net lease stipulates that the tenant is responsible for paying insurance and property taxes on top of the rent. A triple net lease stipulates that the tenant is responsible for paying for insurance, property tax and common area maintenance (CAM) expenses along with the rent.
A triple net lease not only reduces the financial burden but also transfers the financial risks from the landlord to the tenant. Should any of the three expenses (insurance, property tax or CAM) increase then the landlord will not have to absorb the cost, which would affect the properties profitability.
Triple net leases are not very common. They are used by landlord’s looking to reduce their risk. They are usually used on high-grade commercial properties leased to a single client. Lease terms may be between 10 and 15 years with a predetermined escalating rent.
It is in the interest of the landlord to have the tenant sign a double net lease so as to limit the financial risks of increasing taxes or insurance costs. The insurance and tax money will still be paid through the landlord to ensure that it is paid on time and that the right amount is paid.
What are the advantages and disadvantages of a triple net (NNN) lease?
The advantages of a triple net lease (NNN) include more freedom for tenants to make alterations and customize space without having to make a large capital investment, the ability to leverage the added financial responsibility to negotiate lower rents, and protections against tax and insurance increases with the inclusion of caps placed on certain values. For landlords, triple net leases are a low-risk and reliable source of income with few overhead costs.
The drawbacks of a triple net lease include higher monthly costs for tenants, the tenant being responsible for any tax-related liabilities such as fines and penalties, reduced long-term earnings for landlords due to earning caps, the risk of default, and in some cases landlords may still be responsible for the roof and structure of the property.
What are the advantages and disadvantages of a double net (NN) lease?
Advantages of a double net (NN) lease include lower monthly costs for tenants, as well as less financial responsibility for the tenant. The tenant is not responsible for taxes, insurance, or other costs associated with the property. Additionally, the tenant is not responsible for any tax-related liabilities such as fines and penalties.
Disadvantages of a double net (NN) lease include less freedom for tenants to make alterations and customize space, as well as less protection against tax and insurance increases. Additionally, landlords may have reduced long-term earnings due to earning caps, and may still be responsible for the roof and structure of the property.
What are the advantages and disadvantages of a gross lease in commercial real estate?
The main advantage of a gross lease in commercial real estate is that the tenant only pays a flat fee as rent, and the landlord is responsible for all costs related to property ownership. This makes financial planning easier for the tenant, as the rent is flat throughout the lease.
The main disadvantage of a gross lease is that it is usually costlier than net leases. This is because the landlord tries to ensure that costs never drain their cash flow or diminish their margins. Additionally, gross leases may have escalating clauses to counter rising taxes, insurance premiums or maintenance costs (CAM). It is important to fully understand escalating clauses and how that may affect rent in the future.
What are the tax implications of a triple net (NNN), double net (NN) and gross lease in commercial real estate?
The tax implications of a triple net (NNN), double net (NN) and gross lease in commercial real estate depend on the type of lease. With a gross lease, the tenant pays a fixed amount of rent and the landlord pays all of the expenses associated with the property, including taxes, insurance, and maintenance. With a double net lease, the tenant pays a fixed amount of rent plus a portion of the property taxes and insurance. With a triple net lease, the tenant pays a fixed amount of rent plus all of the property taxes, insurance, and maintenance expenses.
The tax implications of a double net or triple net lease are that the tenant is responsible for paying the taxes and insurance associated with the property. The tenant can deduct these expenses from their taxable income, which can reduce their overall tax burden. The landlord is not responsible for these expenses, so they are not deductible.
The tax implications of a gross lease are that the landlord is responsible for all of the expenses associated with the property, including taxes, insurance, and maintenance. The landlord can deduct these expenses from their taxable income, which can reduce their overall tax burden. The tenant is not responsible for these expenses, so they are not deductible.
Conclusion
Commercial real estate leases come in many forms, but gross, double net, and triple net leases are the most common. It is important for landlords and tenants to understand the key differences between these lease types to choose the type that best meets their needs.
Whether you are a landlord looking to minimize your expenses or a tenant looking for stability, it is essential to have a clear understanding of the lease agreement and what expenses you will be responsible for.
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