Commercial real estate leases are foundational agreements between a property owner and a business tenant. These contracts have several structures for handling property expenses. This article will focus on one of the most common types, the gross lease, providing a detailed explanation of its mechanics and applications.
What Is a Gross Lease
A gross lease is a commercial lease where the tenant pays a single, flat rental fee. In this arrangement, the landlord assumes responsibility for all operating expenses, which are factored into the tenant’s rent, creating a predictable payment schedule.
The primary appeal is the cost certainty it provides the tenant, allowing a business to budget occupancy costs precisely. The landlord calculates the rent by forecasting the property’s expenses and building in a margin for profit. This simplicity makes the gross lease a popular option for tenants who prioritize stable overhead.
What Expenses Are Included
Under a gross lease, the landlord is responsible for paying the building’s operating expenses, which are bundled into the tenant’s single rent payment. The landlord bears the risk of any increases in these tax assessments. Major expenses covered by the landlord include:
- Property taxes levied by municipal governments.
- Property insurance for the building’s structure against perils like fire or other damage.
- Common Area Maintenance (CAM) for shared spaces like lobbies, parking lots, and elevators.
- Structural repairs and maintenance for the roof, foundation, and external walls.
While the landlord covers these costs, the tenant is still responsible for their own business liability insurance, utilities consumed directly within their unit like internet and phone service, and any janitorial services for their exclusive space.
Types of Gross Leases
While the term “gross lease” implies a simple arrangement, variations exist that modify how expenses are handled.
Full-Service Gross Lease
The most straightforward version is the full-service gross lease. In this structure, the landlord covers virtually all operating costs, often including utilities like electricity and water, and in-suite janitorial services, in addition to taxes, insurance, and CAM.
Modified Gross Lease
A more common variation is the modified gross lease, which acts as a hybrid between a gross and a net lease. The tenant and landlord agree to split certain operating costs, with specifics negotiated between the parties. A common feature is an “expense stop” or “base year.” In this scenario, the landlord agrees to pay operating expenses up to a certain amount based on the costs from the lease’s first year. If expenses in subsequent years exceed this base amount, the tenant becomes responsible for paying their proportionate share of the overage, which protects the landlord from unforeseen cost increases.
Advantages of a Gross Lease
The primary advantage of a gross lease for a tenant is the simplicity and predictability it offers. This structure shields the tenant from unexpected increases in expenses like property taxes or major repair bills, which is beneficial for new or small businesses with tight cash flow.
From the landlord’s perspective, a gross lease can also be advantageous. If the landlord can effectively manage the property and keep operating expenses below the amount factored into the rent, they can increase their profit margin. This potential for higher returns rewards efficient management.
Disadvantages of a Gross Lease
For the tenant, a disadvantage is that the base rent in a gross lease is higher than in other lease structures. Landlords calculate the rent by estimating future expenses and add a premium to cover the risk of unforeseen cost increases. The tenant does not get to share in any savings if the landlord reduces operating costs.
The main drawback for the landlord is the assumption of risk. If operating expenses rise unexpectedly due to a property tax hike or costly emergency repairs, the landlord’s profit margin is reduced or eliminated. This makes the net income from the property less predictable.
Gross Lease vs Net Lease
The fundamental difference between a gross lease and a net lease is who is responsible for paying the property’s operating expenses. In a gross lease, the landlord pays these costs from the tenant’s flat rent fee. Conversely, in a net lease, the tenant pays for some or all of these expenses directly, in addition to a lower base rent. This distinction shifts the risk of rising operational costs from the landlord to the tenant.
The most common counter-example is the triple net (NNN) lease. Under an NNN lease, the tenant is responsible for paying property taxes, property insurance, and all maintenance costs.
The choice between a gross and a net lease reflects different priorities. Tenants who prioritize budget stability often prefer a gross lease, while those who want a lower base rent may opt for a net lease.
When Is a Gross Lease Most Common
Gross leases are frequently used in specific types of commercial properties. They are particularly common in large, multi-tenant office buildings. In this setting, it is simpler for the landlord to manage building-wide expenses and distribute those costs through a single, inclusive rent payment for each tenant.
This lease structure is also prevalent in executive suites and co-working spaces where tenants look for simplicity and short-term commitments. Smaller retail spaces within a large shopping mall might also use a modified gross lease, simplifying the billing process for both parties.