Businesses usually start out leasing rather than owning their own offices and retail spaces. Leasing gives businesses the flexibility to add or reduce space as needs change and to manage costs consistent with cash flow. The two basic types of leases are gross and net leases. The fundamental difference between the two is in who pays the operating expenses. Gross leases usually include all expenses, while net leases usually include only the rent.
Facts: Gross Lease
The property owner usually pays all of the operating expenses in a gross lease. These include maintenance, utilities, property insurance and municipal taxes. The tenant pays a base rent, which is usually on a per-square-foot basis. The advantage for the tenant is that he knows exactly what his rent expenses will be each month and he does not have to worry about any of the operational details. The disadvantage is that the base rent may be higher and the tenant has no way of controlling the operating expenses.
Facts: Net Lease
Net lease tenants pay a base rent and part of the operating expenses for the premises, including utilities and maintenance. Lease contracts usually contain clauses that protect tenants in buildings with high vacancy rates from having to pay a disproportionate share of the operating expenses. Tenants are also responsible for a portion of the common area maintenance expenses, such as landscaping, building security and janitorial services. Lease rates vary depending on the location and quality of the office space. The advantage for tenants is a lower base rent and some control over operating expenses, while the disadvantage is that the additional costs could significantly increased monthly rent expenses.
Some gross leases contain escalator clauses that automatically pass through increases in operating expenses to tenants. Some gross lease tenants may have to pay common area maintenance costs, which could increase rent expenses significantly.
Net lease types include single-net, double-net and triple-net. Single-net lease tenants pay a base rent plus a portion of the property taxes; double-net lease tenants pay a base rent, plus property taxes and property insurance; and triple-net lease tenants pay a base rent, plus property taxes, insurance and maintenance costs.
Businesses should consider several factors before signing a commercial lease. These include the lease term, the base rent, operating and common area maintenance costs, security deposit and subleasing terms. Businesses may also incur additional upfront costs for modifications to the property. Tenants and property owners should also agree on a mechanism for resolving disputes arising out of the execution and interpretation of lease provisions.
Based in Ottawa, Canada, Chirantan Basu has been writing since 1995. His work has appeared in various publications and he has performed financial editing at a Wall Street firm. Basu holds a Bachelor of Engineering from Memorial University of Newfoundland, a Master of Business Administration from the University of Ottawa and holds the Canadian Investment Manager designation from the Canadian Securities Institute.