Question

For the following question assume that you are taking on the role of a commercial property owner/manager. Which type of lease is riskiest in terms of operating expenses? Why? Which type of lease is least risky in terms of operating expenses? Why? Why might a commercial property manager choose to take on the additional risk associated with tenant operating expenses? How is agency conflict present in the above considerations?

Answer 1

Generally, there are 3 types of Leases.

1. Gross Lease - In a Gross Lease the tenant only pays the rent. He does not take part in property taxes, utilities, maintenance etc. The rent is usually high in this case. Tenants prefer such lease agreement because they don't have to get involved in day-to-day operations of the property.

2. Net Lease - In a Net Lease, the tenant, apart from rent, also pays operating expenses such as taxes, ulitilty bills, maintenance etc. The base rent is lower than that of Gross Lease. Net Lease have 4 sub-types:

2.a Single Net Lease - Here the tenant pays rent and a part of property taxes.

2.b Double Net Lease - The tenant, with rent and part of property taxes, also pays insurance

2.c Triple Net Lease - The tenant pays rent, property taxes, insurance on top of the rent he owes.

2.d Absolute Triple Net Lease - The tenant takes on all cost associated with the property.

3. Modified Gross/Net Lease - This lease offers a middle ground to both tenants and landlords. A broader range of negotiations happen when it comes to operating expenses. The lease rate remains fixed even if costs increase of decrease.

A Gross Lease is more riskier when it comes to Operating expenses because the tenant does not take part in payment of property taxes, utilities, maintenance etc. The rent, even being higher, is still fixed irrespective of the cost incurred by the tenant.

A Net Lease is the least risky in terms of operating expenses as the tenant takes part in payment of operating expenses. This arrangement come with a lower base rent.