Types of Commercial Leases/Rent Structures: Modified Net/Gross

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 said, 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.

mad-scientist

Modified Net/Gross

Now we come to the commercial leases/rental structures that simply refuse to conform to convention. They just have to be different. While this can be frustrating when attempting to quantify the overall costs of leasing space, there are benefits to this a la carte approach.

Who?

You typically see modified rental structures with condominium projects and/or smaller/individual landlords.

Why?

Just to be pains in the butt? No. Rather it’s because condo units (office, industrial, flex, or, in rare cases, retail) are separately metered and it can make sense to include some charges in the rental rate and exclude others. For example, with an office condo the owner may offer a rental rate which is net of utilities and cleaning. Utilities are already billed to the individual unit; making it easier for the tenant to directly pay these costs based on their use. An additional benefit is the resulting lack of “regular business hours” for utilities; allowing tenants to only pay for the hours and amounts they consume. The same idea applies to cleaning.

Another reason is that modified rental structures may allow the landlord to advertise a lower face rate than their full-service counterparts. By having the tenant pay these costs directly they do not have to overstate the amounts as a hedge against excessive usage. In an office market where full-service rates are around $30 per square foot, a landlord may advertise a rate of $27 per square foot net of utilities and cleaning (estimating that such costs are about $3 per square foot), which to the laymen looks like a better deal when in reality it may end up being more expensive for the tenant.

In addition, because condos are owned by individuals or smaller companies these landlords will opt for a rental structure that best suits their needs and preferences rather than what market typically dictates. An owner of an office condo may charge a modified net rent because they don’t want the accounting hassle of reconciling the varying amounts under a full-service lease. They would rather simply invoice the tenant directly for the individual costs (bills they receive).

Finally, cheapskate landlords may quote a modified rental rate to save on brokerage commissions. Because agreements typically stipulate that the commissions are paid on the lease value which is based on the total rent paid over the term; by separating rent from other charges the landlord understates the lease value on which the commission is based.

What?

It’s hard to make a general statement on what tenants can expect from a modified rental structure. Of key importance is understanding what each structure means from a cost perspective and what the tenant is responsible for as a result. A tenant whose business operates outside of regular business hours or who requires special services based on the nature of their business may realize cost savings by excluding the specific costs from operating expenses/CAM and paying only based on their usage and/or specific needs. Industrial, flex, and retail users may have one of the traditional “nets” included in their rent such as CAM, but may still be required to maintain, repair, and even replace the systems servicing their unit.

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