Commercial leases are much less understood than typical leases for residential property.
Even if you have previous experience renting residential units, you may be unfamiliar with the new set of rules for commercial properties. Some management principles will be the same, but your rental business operates differently when your tenants are business owners themselves.
If you’re new at commercial leasing and understandably confused, don’t panic. The purpose of different commercial lease types is to adapt to the specific needs of you and your tenants.
Commercial leases are flexible and can support different kinds of businesses, depending on the tenants’ goals and how trustworthy you deem them.
Here is a concise overview of the three types of commercial leases and some tips for deciding which one to use.
1. Net Leases
Net leases are the most common type of commercial lease. In a net lease agreement, the tenant holds most of the financial responsibility to maintain the property. Tenants usually cover utility costs in addition to rent, which tends to be lower.
There are four different levels of net leases for additional costs the tenant must cover.
- Single Net – The tenant pays for their share of the building property tax in addition to utilities and rent.
- Double Net – The tenant pays for everything in a single net, plus insurance.
- Triple Net – The tenant pays for everything in a double net, plus common area maintenance expenses.
- Absolute Net/Bonded – The tenant is responsible for all property costs, including damages and construction.
Remember, the more financial responsibility you give your tenant, the higher standard for creditworthiness you should use.
2. Percentage Leases
The second type of commercial lease is the percentage lease. These are common for retail properties. They generally consist of a base flat rent (typically lower) plus a percentage of the tenant’s business revenue.
Percentage leases balance the goals of both landlords and tenants. The success of the tenants’ business means success for everyone—the tenant generates more revenue, and you accrue more rent with the same percentage.
To help tenants just starting their businesses, landlords using percentage leases often set a breakpoint. Until a predesignated sales limit, or breakpoint, you exempt tenants from paying the additional percentage amount.
You want a lower breakpoint while your tenants want a higher one. It’s in both parties’ best interests to compromise.
3. Gross Leases
Net leases give landlords more power, while percentage leases help both landlords and tenants achieve their goals. In contrast to these types, gross leases favor tenants.
There are two types of gross leases.
1. Full-Service Gross Leases – In a full-service gross lease, tenants pay one lump sum amount for rent, which you, as the landlord, then use to cover building expenses. Tenants prefer this lease type because it clears them of responsibility after the initial payment.
2. Modified Gross Leases – In a modified gross lease, tenants still pay a lump sum for rent, but the landlord only covers some expenses. This may be because a tenant requires specific services or amenities for their business, like special industrial appliances that use more electricity or water. Modified leases can be negotiated with all the individual tenants in a building.
Full-service gross leases are best for single tenants, while modified gross leases can accommodate multiple tenants with different needs.
Choosing a Commercial Lease Type
Your choice of commercial lease type depends on the purpose of your tenants’ business endeavors and their creditworthiness.
Tenants running highly specialized or niche businesses should be willing to take more responsibility for their utilities and other expenses. For these tenants or buildings with multiple tenants, lease structures with more flexibility are better (triple net, absolute net, and modified gross).
However, the more responsibility you hand your tenants over the building, the more you should trust them. If you choose a triple net or absolute net lease structure, make sure you take tenant screening seriously. Use a high minimum for credit score to ensure your tenants can afford to maintain your property through damages and repairs.
If you’ve previously owned residential rental property, you may have used property management software for tenant screening. You can also screen your commercial tenants and manage their rent on most software platforms. You should, however, read about how screening commercial tenants differs from residential ones, such as how a business credit score works.
Managing Your Commercial Properties
Understanding commercial property is a challenge. However, having multiple options for lease types lets you control how you and your tenants will share responsibilities for the property. You decide how involved you want to be. If you explain the terms clearly to your tenants, you can begin strong relationships with your new commercial tenants.