Commercial real estate leases come in various forms. Whether you’re a landlord or a tenant, understanding the intricacies of different lease structures is crucial for drawing up rental contracts that suit all concerned. Gross leases in commercial real estate are often used for retail spaces and office buildings. But what is a gross lease, and how does it play out?
Gross leases in commercial real estate refer to agreements where the tenant agrees to pay the landlord a flat fee for the exclusive use of the property. The rent covers all operating costs, including property taxes, standard utilities, insurance, and other expected expenses, such as maintenance.
There are four commonly used lease agreements in commercial real estate: gross, net, percentage, and variable. If you’re due to conclude a lease agreement, it’s essential to understand the details of the contract when you sign on the dotted line. Read on to discover the inner workings of gross leases in commercial real estate, including their benefits and drawbacks for both parties.
What Are Gross Leases In Commercial Real Estate?
A gross lease is an agreement typically used in commercial real estate to simplify the process for landlords and tenants. In contrast to other agreements, such as net leases, which require tenants to pay specific costs in addition to rent, a gross lease bundles most or all of the property’s operating costs into a flat monthly or annual rental payment.
The flat fee usually includes the following expenses:
- Insurance
- Property taxes
- Utilities
- Maintenance
- Common area upkeep (CAM)
- Other regular expenses
In a gross lease agreement, the landlord takes responsibility for paying all property-related expenses. They will calculate the rent using historical data or by analyzing the property’s actual and potential expenses.
Once a figure is reached for the rent, the parties can also negotiate the terms and conditions. For example, a tenant may request the landlord to include additional benefits, such as landscaping or cleaning services.
Types Of Gross Leases
Gross leases don’t always come in precisely the same formats. On occasion, tenants and landlords may require adjustments to straightforward gross (or full service) leases.
A Modified Gross Lease Splits Operating Costs
A modified gross lease comprises an agreement where the tenant and landlord both pay for specific operating costs. Long-term commercial leases often use these agreements. The tenants can often bring the rent costs down because they are responsible for some additional costs.
In a modified gross lease, the tenant may pay additional costs for utilities and cleaning services. It may appeal to them because they have more control over who provides the services and the quality thereof. They are not dependent on the landlord’s choice of provider.
A Gross Lease With Stops Protects Landlords
Landlords may sometimes be reluctant to take on the entire risk of skyrocketing operating expenses, preferring to opt for a gross lease with stops. With a full service lease, the tenant continues to pay the same rent, regardless of any exorbitant increases in operating expenses. In this situation, the landlord covers the price increases and suffers a dent in his profits.
Landlords may build in some cushioning for such events, offering tenants a gross lease with stops. The agreement includes a clause requiring the tenant to pay toward specified running costs when they reach a particular ceiling.
The Benefits And Drawbacks Of Gross Commercial Leases
Cracking the lease code in commercial real estate smooths the negotiations when it’s time to finalize the rental agreement. By unpacking the details of gross leases, both parties will have clarity regarding their responsibilities. This type of rental agreement has benefits and drawbacks for landlords and tenants, but it is still a workable solution under the right circumstances.
Understand The Benefits And Drawbacks For Tenants
Entering into a gross lease presents the tenant with several advantages and disadvantages. On the bright side, they experience the following benefits:
- It simplifies budgeting as most or all known running costs fall under the flat rental fee.
- The tenant pays a fixed regardless of price hikes in expenses.
- The tenant is not responsible for paying expenses on time; they only need to pay their rent by the due date.
- The tenant is not responsible for maintenance costs and repairs.
But it’s not all sunshine and roses. Gross leases also present some drawbacks for tenants:
- Gross lease rental amounts are usually higher than with some other contract types.
- Landlords could overcharge to protect themselves against potential losses.
- Landlords sometimes take longer to do repairs or take shortcuts when fixing property issues.
Landlords Also Experience Pros And Cons With Gross Leases
Landlords enjoy certain advantages with gross leases in commercial real estate:
- Landlords can charge higher rent because they assume all risks and responsibilities for operating costs, which increases their profits.
- They can add an annual increase without declaring which expenses have increased and to what extent.
- A gross lease is often seen as tenant-friendly, making the property more marketable to businesses that value the predictability and stability of a gross lease.
- Gross leases may reduce the risk of vacancy because unexpected costs are minimal.
There are also some downsides for landlords:
- The risks and operating expenses can minimize the landlord’s profits.
- The administration, payments, and maintenance take time, effort, and money.
The Right Fit For Gross Leases In Commercial Real Estate
Rental agreements are not a one-size-fits-all, and this also applies to gross leases. Gross leases may suit certain types of commercial real estate, such as office buildings, condo towers, retail spaces, start-ups, and medical facilities.
On the other hand, they may not work for other types of commercial real estate, like warehouses or industries with specialized needs where tenants require more control over their expenses and management.
The Bottom Line
Gross leases in commercial real estate refer to the all-inclusive rental agreements that require the tenants to pay a flat fee, which includes all operating costs associated with the property. The landlord shoulders the burden for these expenses but usually benefits by inflating the rent. When used wisely, gross leases can lead to successful, long-lasting business relationships.