Tenant Reimbursements: What You Need to Know
Tenant reimbursements, also known as tenant recoveries, are expenses which are paid back to a landlord by a tenant. Common examples of tenant reimbursements include property taxes, property insurance, maintenance and repair costs, and other operational expenses. Often, landlords will bill the average expected cost of these expenses to a tenant each month, which will often be labeled as “additional rent.” At the end of the year (or the end of the lease) the landlord will reimburse the tenant if actual costs are less than expected costs. Alternately, the landlord will bill the tenant any additional expenses that were not covered by their monthly tenant reimbursement bill.
Tenant Reimbursements in Relation to Gross Leases
In a gross lease, the landlord is responsible for most or all of the expenses of operating and maintaining the property. As a result, tenant reimbursements are rare in gross leases, and will typically only occur if a new expense has cropped up that was not specifically covered (or was specifically excluded) from the terms of the gross lease. In commercial real estate, gross leases are most common for small office tenants, and are relatively uncommon when it comes to larger commercial or retail tenants.
Tenant Reimbursements in Relation to Net Leases
Unlike gross leases, net leases are structured so that a tenant is responsible for their share of a property’s operating expenses. Net leases can come in several different varieties, including double net leases (NN leases), in which a tenant is responsible for paying insurance and property taxes in addition to their rent. They can also come in the form of triple net leases (NNN leases), in which a tenant is responsible for paying insurance, property taxes, and common area maintenance (CAM) fees on top of rent. In some scenarios, a net lease may be structured as a bond lease, also referred to as a “hell or high water lease,” which stipulates that a tenant will need to pay their rent, no matter what happens to the property in question.
In most forms of net leases, especially NNN and bond leases, tenants must pay any unexpected maintenance or repair costs, including the costs of repairing or cleaning the property after floods, snowing, storms, or other natural disasters and weather issues. Tenants are generally responsible for paying their pro-rata share of operational expenses. For instance, if it took $20,000 to clean a property after a storm, and a tenant occupied 60% of the property, they would need to pay $12,000 in tenant reimbursements.
Many Commercial Leases Contain Aspects of Both Gross and Net Leases
While it’s true that pure gross and pure net leases exist, in many cases, commercial leases contain aspects of both. For example, a lease could make the landlord responsible for paying for a building’s property insurance, but could make a tenant responsible for paying a certain portion of CAM fees. In addition, many leases contain what’s called a “stop clause,” which stipulates that a tenant is responsible for paying for certain expenses if they go beyond a certain, pre-set amount. These complexities are why it’s essential for commercial real estate investors to gauge the risks and benefits of different types of leases before deciding on the exact commercial lease structure they want to offer to tenants.