Net Lease Vs Gross Lease: Which is Right For Me?

Whether you’re a tenant looking to lease a commercial space or a landlord looking to rent out a commercial property, it’s necessary to understand the ways to negotiate a property lease in Massachusetts.

Commercial leases and residential leases differ in fundamental ways. Residential leases are for facilitating housing while commercial leases are focused on business concerns and business use issues. In general, Massachusetts tenancy laws and consumer protection laws apply to residential tenants differently than commercial tenants.

Both commercial tenants and landlords tend to often focus on “the rent” when negotiating a commercial contract while allowing other very important provisions to go unaddressed. The cost per month, however, can differ greatly in price depending upon the kind of commercial lease that the two parties agree to sign.

In Massachusetts, most commercial leases are gross leases or net leases. Learn the difference between net and gross leases to determine which is best for you.

What Is a Gross Lease?

A gross lease is where the tenant pays a fixed amount each month that covers the base rent as well as other costs like property taxes, maintenance, and insurance. Of course, the final contract can have exceptions where the tenant agrees to pay some additional costs along with the fixed amount.

A gross lease is all-inclusive and may also include things like utilities and janitorial services. Any excess utility usage will typically become the responsibility of the tenant, so it is important to identify these terms at the negotiation stage. Gross leases tend to be easier for the tenant to manage, allowing for predictable expenses and less responsibility for the building. Gross leases can also involve some variation for the landlord, as prices fluctuate. Any savings or extra costs go to the landlord.

What Is a Net Lease?

A net lease, most commonly known as a Triple Net or NNN lease, requires the tenant to assume most of the operating costs of the property separately from the base rent. These expenses are often known as the three nets — insurance, maintenance, and property taxes. They can vary from month to month, meaning it is a less predictable approach for the tenant.

Like the gross lease, however, the tenant and the landlord can agree to craft a net lease where a tenant will pay more or fewer of the associated operating costs. Some fees associated with a net lease can include utilities, janitorial services, condominium common area fees, trash collection, property taxes, landscaping, and parking lot management.

Additionally, several different types of net leases break these charges down in different ways. They are often broken down by the portion of the building occupied by the tenant.

Net leases tend to be landlord-friendly and require the tenant to be particularly diligent in negotiations and understand the ways that a net lease can increase or decrease over time. It may be harder to predict. Some tenants prefer this model, though, as it is more transparent in terms of what they pay for operating expenses, and monthly rent may be lower.

How Is Rent Determined?

Whether you’re talking about a net lease or a gross lease, rent is normally determined by setting a price per square foot, either per month or per year. This is known as “base rent.” The landlord typically calculates base rent by the amount of rentable square feet (RSF) rather than usable square feet (USF). RSF comprises the entire interior space of a property. This means that it may contain what might otherwise be “unusable” spaces like utility closets or support pillars that restrict the amount of space the tenant can use for their business. USF is the entire interior space minus those areas the tenant cannot use.

For example, if a lease is based on $15 per square foot per year for 3,000 RSF, the tenant’s base rent will be $45,000 a year. This means that the tenant will pay $3,750 a month for their base rent.

Many leases also contain an escalation clause. This clause raises the rent each year to offset increasing building expenses. Sometimes the landlord and tenant negotiate this increase at the end of each financial year, so the amount can be more flexible depending on whether costs for the landlord have risen or declined. The tenant and landlord may also use a fixed rent increase, which they agree upon when they sign the original lease. This is known as a “step increase.”

When the lease ends, the tenant and the landlord may agree to extend the lease. They will negotiate how long this lease extension will last and what the new rent will be. A fixed extension is straightforward. This means that the rent will increase yearly based on an agreed-upon percentage or amount. More common is a lease extension based on the fair-market-value (FMV). An FMV extension means the rent will increase based on what it would cost to rent a similar space in the market at the time the landlord and tenant negotiate the extension rather than a previously agreed-upon amount.

Additional rent is determined differently based on whether you have a gross lease or a net lease.

1. Gross Lease

Also known as the Full-Service Lease, the gross lease has benefits for both the tenant and the landlord, but is commonly seen as the most tenant-friendly form of lease since the rent covers all costs. In a straightforward gross lease, the rent will include:

• Utilities
• Taxes
• Property insurance
• Common Area Management Services (CAMS)

CAMS can include many maintenance items, such as sewer, trash collection, water, parking lot maintenance, snow removal, landscaping, janitorial services, and lobby concierge services.

In some cases, the landlord will establish a cap on utility use. If the tenant’s utility costs go beyond this cap, then the tenant must pay the difference.

With a modified gross lease, the tenant pays a lump sum but also agrees to pay the landlord for utilities and some other operating costs. For instance, landlords commonly use modified gross leases when multiple tenants occupy one building, such as in an office building. An office tenant may pay base rent plus the expenses for their particular unit.

How a tenant pays for utilities depends on whether the building has a single meter or separate meters. If the building has a single meter, tenants typically pay the landlord a percentage of utility costs based on the proportion of the building they occupy. If the building has multiple meters, tenants likely pay the utility companies directly based on their actual use.

Tenants with modified gross leases usually also pay for a percentage of common area services, taxes, and insurance based on the proportion of the building they occupy.

Benefits of a Gross Lease for the Tenant

The main benefit of a gross lease for the tenant is that they know they will have one fixed cost every month. This makes it relatively easy to forecast expenses throughout the year. Under a gross lease, a tenant won’t have to worry about variable costs such as utilities or unexpected costs such as dramatic shifts in property value that cause taxes to increase.

A gross lease can be a great idea for a new business. Someone who is starting their business or renting a property for the first time may find it easier to deal with expenses when using a gross lease. A gross lease can also be a good idea for a tenant who rents multiple properties. Again, it is much easier to determine expenses when you’re working with a fixed amount across several properties rather than having to do separate costs for each rental property.

Gross leases can become a burden for the tenant if operating costs decline and the tenant is paying more than they would in another location or under a net lease. When a tenant signs a gross lease, they need to make sure that they are not overpaying just to have a predictable monthly rent.

Benefits of a Gross Lease for the Landlord

While a gross lease is usually seen as more friendly towards tenants, there are also possible benefits for landlords. First, the rent for a gross lease is always higher than the rent for a net lease. The reason is apparent — the gross lease includes most or all operating costs. The landlord, however, determines the rental fee based on an estimate of potential expenses. In some cases, the landlord can overestimate the costs to protect themselves and pass that on to the tenant. If actual costs are less than estimated, the tenant still pays the same amount, and the landlord benefits from those savings.

Suppose the cost of electricity declines or property insurance is less than it was the year before. The landlord may be able to find a new company to do janitorial services at a lower cost. All of these savings accrue to the landlord.

Gross leases can become a burden for landlords if operating costs rise dramatically, such as a spike in property taxes or CAMS costs. If the lease does not already specify provisions for these increases, the landlord will be responsible for assuming all of these extra costs.

2. Net Lease

A net lease will almost always have a lower base rent for the property because the tenant covers expenses typically associated with ownership. In many cases, the lease will also deal with “unusual costs,” which include items like a new roof or new flooring. Under a net lease, the landlord will normally pick up these unusual costs.

Unlike a gross lease, however, the tenant is responsible for paying additional costs or “nets.” There are three nets:

• Taxes
• Property insurance
• CAMS

With a net lease, the tenant is responsible for paying these additional costs in exchange for paying a lower base rent.

There are three different kinds of net leases:

• Single Net Lease (N Lease): With the single net lease, the tenant will pay a base rent plus property taxes. The amount of property tax will depend on whether the tenant is the only tenant of the property or one of many tenants. If the tenant is a sole tenant, they will cover all property taxes. If the tenant is one of several tenants, the tenant will pay a pro-rated share of these taxes. In most cases, the tenant will also pay utilities and their own janitorial costs.
• Double Net Lease (NN Lease): In a double net lease, the tenant pays base rent plus property taxes and property insurance. The amount again depends on whether the tenant is the sole occupant of the property or one of several occupants. The tenant is still responsible for their own utility and janitorial costs.
• Triple Net Lease (NNN Lease): The triple net lease is the most common when a single tenant is renting an entire building, especially for a long time. With the triple net lease, the tenant pays all the nets — property insurance, real estate taxes, and CAMS, along with janitorial and utility expenses. This is commonly known as a “turnkey operation.”

A less common option with a net lease is the “Absolute Triple Net Lease.” Under the absolute triple net lease, a tenant is responsible for assuming real estate risk to the property. If the property is destroyed in a natural disaster or the building is condemned, the tenant is responsible for any construction costs to rebuild the property. This is also known in Massachusetts as the “hell-or-high-water lease.”

Even if a tenant signs a triple net lease, this does not mean they will pay every cost associated with the property. For instance, the tenant won’t pay any of the landlord’s accounting costs or the legal costs that the landlord’s attorneys charge when reviewing or drafting documents.

Benefits of a Net Lease to the Tenant

At first glance, this form of lease would not seem to be very favorable to the tenant. After all, they’re still paying a base rent but also assuming most or all operating costs depending on the kind of net lease they have signed.

However, advantages for the tenant include transparency of costs. While a tenant doesn’t have to pay for additional costs under a gross lease, they also have no idea whether they’re overpaying for any of these items. With the net lease, the tenant has much more control over these expenses and can make better budgeting decisions.

Tenants can also have more control over additional costs with net leases. If the tenant finds a landscaping company that charges less, or they rent multiple properties and can bundle insurance expenses, they keep these savings.

Of course, lower base rent is also an advantage. If a tenant pays close attention to their operating costs, the lower base rent means that what they pay out over a year could be even less than what they would pay with a gross lease.

Benefits of a Net Lease for Landlord

The landlord does obtain the primary advantage in a net lease, particularly with the triple net lease. Under a triple net lease, the tenant assumes the lion’s share of the operating costs. This lease type provides the landlord with a much more predictable flow of income from the rental property since they are not subject to any changes in their operating costs. If the landlord uses triple net leases at several properties, their ability to forecast their income accurately is much greater.

A triple net lease presents a landlord with the opportunity of having a turnkey property investment.

On the other hand, it does mean that the landlord might not make as much money as they would under a gross lease. If operating costs decline, for instance, the benefit goes to the tenant and not the landlord.

Choosing the Right Lease Type

At heart, a lease is simply a legal contract where a tenant agrees to pay a certain amount to rent space over an agreed-upon period. What type of lease the tenant chooses will depend a great deal on their business, their projected cash flow, and their ability to pay the rent monthly.

For Tenants

When looking at properties, potential tenants must look beyond what a property may advertise as its rent and not make their decision on that factor alone. For instance, if the tenant is interested in renting a property in Massachusetts, and they see a property in Lowell and one in Boston both advertised as having the same rent for the same amount of space, it would seem to be a basic choice about which is the better location.

Upon closer examination, however, the tenant learns that the property in Boston is a gross lease while the property in Lowell is a triple net lease. Since gross leases include operating costs and triple net leases do not, the tenant would likely pay more for the Lowell property than for the one in Boston. The type of lease is an essential factor to consider when deciding which location to use.

For Landlords

For a landlord, determining what kind of lease to use with a tenant depends on several factors as well. Perhaps the most important factor is the creditworthiness of the tenant. If a landlord is leasing the property to a well-known national client, there are fewer financial risks involved than leasing to a start-up or small local business. A landlord must also consider how involved they want to be in managing the property. Net leases are excellent for investors who purchase properties for the income they can produce and are willing to accept a slightly lower but steadier income for more hands-off ownership.

For Both Parties

In either case, the tenant and the landlord need to perform their financial due diligence. Under Massachusetts law, a commercial lease must specify all terms. There can’t be any hidden costs that suddenly appear. It is incumbent on both parties to have a clear picture of what the agreement entails.

Landlords have the responsibility to outline all of the expenses for which a tenant is responsible. On the other hand, the tenant needs to make sure they understand what a gross lease or net lease means for them and what might happen if they fail to meet their obligations under the lease. Although it may seem obvious to say so, the tenant needs to read the lease carefully before they sign it.

Since negotiating a lease can be complex and difficult, it’s always a good idea to hire a real estate lawyer. The specialists at Calabrese Law Associates are familiar with the laws and regulations about commercial leases on both the municipal and the state level in Massachusetts. When you work with a knowledgeable attorney, both tenants and landlords can avoid making crucial mistakes and come up with a much more fair and equitable agreement.

Contact Calabrese Law Associates to Help You Negotiate a Commercial Real Estate Lease in the Greater Boston Area

With legal offices in Boston and Burlington, Calabrese Law Associates is dedicated to providing our clients with the very best in legal services.

When you work with our lease preparation lawyers, you work with knowledgeable real estate attorneys who understand the ins and outs of commercial real estate management and leasing throughout Massachusetts. Our attorneys provide exceptional lease preparation and negotiation services to tenants or landlords regardless of the kind of commercial real estate in question.

Calabrese Law Associates leasing attorneys have the know-how and the skill to help you negotiate an advantageous lease, whether you are a landlord or a tenant. They can advise on the pros and cons of each kind of lease agreement. When you ask Calabrese Law Associates to prepare a lease agreement, you get to focus on business activities that produce revenue and not potentially costly disputes.

To learn more about working with the experts at Calabrese Law Associates, give us a call at (617) 340-6623 or submit a contact form. We know how important it is to make speedy business dealings and will get back to you as quickly as possible. Get in touch today to start negotiating your next commercial lease.

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