Unlike residential real estate where contracts and forms come in templates that are, for the most part, fill-in-the-blank with little room for modification, it seems that no 2 commercial real estate leases (or contracts) are the same. They typically contain many of the same provisions but vary from landlord to landlord (or better put, attorney to attorney). That being said, there are 2 basic types of commercial leases that are organized around the rental structure or calculation method: “net” and “gross.” In this series I will go through the “Who,” “Why,” and “What” of these 2 rental structures/commercial leases; explaining who typically uses which, why they use that particular rent calculation method, and what you can expect from each. I will also touch on the “third” type of commercial lease/rental structure, which is a combination of the two.
Gross Lease (Full-Service)
Other names for gross leases are “full-service” or “full-service gross.” As these names imply the rental structure of this type of lease includes all leasing costs in the rental rate. Leasing costs include common area maintenance (CAM), operating expenses (sometimes synonymous with CAM), real estate taxes, insurance, janitorial services, utilities, etc. The landlord estimates these costs and adds them to the amount they want to net from leasing the space. For example, if the landlord estimates these costs to be $10 per square foot and wants to net $20 per square foot from leasing the space they will quote a rental rate of $30 per square foot, full-service.
Landlords must always consider market conditions when setting their asking rate. This is one reason that landlords have an incentive to keep costs as low as possible. If the market rental rate is $30 per square foot and landlord A has costs of $10 per square foot and landlord B has costs of $12 per square foot, landlord A has a competitive advantage. They can advertise the same asking rate as landlord B and make a $2 per square foot greater profit. Landlord A also has the option of reducing the final negotiated rate by up to $2 per square foot and still remain as profitable as landlord B which also gives them an edge in attracting and securing tenants (all other things being equal).
Landlords are able to maintain their profit margin by charging tenants for any increases in the costs of ownership as pass-throughs (discussed in greater detail in my article What Are Pass-Throughs?) as well as through annual escalations.
Full-service leases are most commonly used in office leasing.
Due to the relatively uniform nature of the tenants’ use of the space (not business type), office landlords are able to predict and apportion the costs of occupancy amongst tenants. A law firm will not require substantially more electricity, water, janitorial services, etc. than an IT company. Common areas are shared by tenants and the costs of ownership are thus easily charged to tenants based on their proportionate share of the building (tenant’s square footage divided by the total building square footage).
Full-service rental structures are convenient for tenants because all of their costs are included in one, easy payment. Tenants can expect to be charged for increases in those expenses over their base year and are responsible for costs specific to their business such as taxes and insurance (general liability, personal property, etc.). Furthermore, if a tenant consumes utilities in excess of what is considered to be building standard, i.e. electricity, such utility service will be separately metered. Also if a tenant requires services above and beyond that offered to other building tenants they will be required to contract and pay for that service directly. An example of this is if a government contracting company has a SCIF within their space and/or has higher security requirements they may be required to contract with a cleared janitorial company.