What is the Difference between Gross and Net Leases? February 1, 2017 | Alex Richardson

Commercial leases are never one-size-fits-all; every one is different and comes with its own, unique challenges.

At the highest level, there are two main types of commercial lease: Gross and Net. The type of lease affects who pays for several expenses associated with the property, and as a result, affects how certain interests are aligned in the landlord-tenant relationship.

 

What is a gross lease?

Under a gross lease, the tenant pays a single flat fee for the use of the space. The landlord agrees to pay for any and all expenses that come with the property and its use, including taxes, insurance, utilities, and often repairs.

Landlords factor in the costs that they are taking on under a gross lease into the cost of rent. There are advantages and disadvantages to this approach for each party.

Tenants might prefer a gross lease because it makes budget planning extremely simple. There are no variable costs whatsoever associated with the property – they will pay the fixed cost and that it the end of the story.

Landlords who plan to make energy efficiency investments in their property may also prefer a gross lease. Because the landlord is paying the utility costs and passing on a fixed cost to the tenants, he or she can easily recoup these costs. Because the tenant will continue to pay the same, agreed-upon rate even after the cost of utilities goes down, the tenant effectively subsidizes the cost of the upgrade.

Unfortunately, gross leases give tenants no real incentive to reduce their resource consumption. They are already paying a fixed cost for the use of resources like water and energy. This misalignment of interests can sometimes be mitigated through dialogue and subsequent agreements between tenants and landlords.

 

What is a net lease?

A net lease is precisely the opposite of a gross lease. Under a triple-net lease, the most common type of net lease, tenants cover taxes, utilities, and operating costs in addition to paying the landlord for the use of the space.

As with a gross lease, the cost of rent factors in these additional expenses, and so is much lower under a triple-net lease. While triple-net is the most common type of net lease, modified lease structures exist to cover any possibility. Under a “net of electric” lease, for example, the landlord covers most expenses, but the tenant is responsible for electricity consumption.

A net lease reverses the advantages and disadvantages of a gross lease. Tenants are motivated to reduce their utility consumption, but landlords have no immediate incentive to make energy efficiency retrofits beyond the long-term value of their property, and no easy way to recoup their expenses. For example, a landlord who invested in high R-value windows would be lowering his tenants’ heating costs, but would see none of the energy savings personally.

Again, however, this misalignment of interests may be remedied with landlord-tenant collaboration.

About The Author

Alex Richardson is a staff writer at Aquicore. He writes about green policy, energy efficiency, and innovation that affects commercial real estate. Alex.Richardson@aquicore.com.