Which lease should you negotiate for?
There are several types of leases commonly utilized in commercial real estate. It is important to understand these different leases in order to properly compare and contrast them when analyzing and negotiating for your company. There are modified gross leases and net leases. Most industrial facility leases are either modified gross or net. These forms of leases refer to roles and responsibilities, and how various costs are paid for between the landlord and the tenant.
Modified Gross Leases
Modified gross leases (or industrial gross leases) are commonly utilized in industrial facilities. They are comparable to full-service gross leases, but some specific operating expenses are paid directly by the tenant. Normally, tenants pay their own utilities and janitorial services. However, every situation is a little different, and many times these costs and responsibilities are negotiable.
Similar to gross leases, net leases appear in many varieties. Net leases require the tenant to pay some or all expenses directly related to the property. These expenses can include property taxes, insurance, maintenance, repairs, utilities, janitorial services, and other operating costs. The three most common net leases are:
Single Net (SN)
The tenant pays a lump sum base rent plus property taxes. The landlord is responsible for all other operating expenses.
Double Net (NN)
The tenant pays a lump sum base rent plus property taxes and insurance. The landlord is responsible for all other operating expenses.
Triple Net (NNN)
Triple net leases are most commonly used for single tenant industrial facilities. The tenant is almost completely responsible for every operating cost related to the building. In addition to paying for taxes, maintenance, and insurance, tenants are also responsible for all costs associated with occupancy, including utilities, personal property taxes, and janitorial services. In most cases, the landlord is responsible for the roof and the structure.
Other Lease Considerations
Regardless of the type of lease you are considering for industrial space, it’s important to clarify specifically what you will and will not be responsible for. Remember, in many situations, cost responsibilities and pass-throughs are negotiable. Also, in multi-tenant buildings, it is important to clarify parking allocations upfront, to avoid issues and disputes down the road. It’s also important to remember that, the longer the term, the more valuable the lease is to the landlord. Generally, the building owner will offer more tenant improvement allowance, rent abatement, and other concessions in exchange for longer term leases backed by excellent credit. This provides a higher certainty of positive cash flow from the owner’s investment and, generally, landlords are willing to make concessions up front to guarantee that positive cash flow.
Tenants, on the other hand, prefer flexibility. They want the ability to remain nimble as the businesses scale up and down in order to meet demand and other business requirements. To capitalize on the landlord’s appetite for length of term while still maintaining some flexibility, some of our clients assume long-term leases with cancellation options. Typically, landlords will require some form of compensation if the option is exercised, such as an early cancellation fee, to minimize loss from vacancy and to cover initial startup costs. Some of our clients have rapidly changing business models and simply cannot commit to a specific space for more than three to five years. They pay more for rent and generally receive fewer concessions, but they have more mobility and flexibility associated with the shorter term.
By understanding the difference between these different leases, you will be able to properly compare and contrast them during negotiations. Having a trusted advisor guide your decision throughout the process is a great way to make the right decision for you and your business.
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