One of the most important yet misunderstood topics in industrial real estate leases is the difference between a “gross” lease and a “net” lease. Many times I’ll receive a call from a prospective tenant on one of my listings that goes something like this:
Tenant: Hi, I’m calling on your listing at 1787 E. 46th St. What is the price per square foot for that building?
Me: That unit is available at $0.81 PSF gross.
Tenant: $0.81 PSF???!! What?????!!!! But there is a very similar unit, about the same size, also dock high, at the Malburg business park in Vernon that is on the market for $0.63 PSF.! Will your owner accept a deal at $0.63?
Me: That unit on Malburg is available for $0.63 “net”. When you add the real estate taxes, property insurance and common area maintenance charges that the tenant is responsible to pay in addition to the Base Rent, that $0.63 PSF turns into $0.83 PSF.
Tenant: Uhhhhh..really?
The “net” charges (also referred to as “NNN charges” or “net-to-gross” charges) can vary substantially from property to property, but generally are in the $0.10 to $0.25 PSF range in the Central and South Bay industrial markets.
Here’s a quick explanation of what the tenant is responsible for under each type of lease. Because the “extra” charges also vary based no whether the building is free-standing or located in a multi-tenant industrial park, let’s divide it into the four possible scenarios. I’ve simplified a few things below to make it a little easier to understand.
I. Gross Lease – Free Standing Building (“Single Tenant”):
Tenant pays Base Rent. Owner pays the Base Property Taxes and the Base Property Insurance Premium, which are essentially (1) the amount of property taxes payable for the building in the calendar year when the lease commences; and (2) the insurance premium amount for the twelve month period preceding the commencement date of the lease. The tenant is responsible for increases in the property taxes and property insurance over the base amounts that the owner is paying.
So assume that the property taxes for the building are $5,000 per year, and the insurance premium is $1,000 per year when the lease starts. Those amounts are the owner’s responsibility to pay throughout the lease. So for the first year of the lease, tenant pays zero property taxes and zero property insurance. Let’s say after the first year of the lease, the property taxes increase to $5,200 and the insurance premium increases to $1,100. Owner pays the Base $5,000 in property taxes, tenant is responsible for the $200 increase. Owner pays the Base Insurance Premium of $1,000, tenant pays the increase of $100. So that’s a total of $300 payable by the tenant, or $25 per month, for the second year of the lease term. Except in very rare cases, or if the tenant has been in the building for a very long time, or when the property is sold and re-assessed (more on that in the blog post “Prop. 13 Protection (or Lack Thereof) in Your Lease”), these increases are not significant out-of-pocket expenses for the tenant.
Tenant is responsible to pay out of pocket, directly to each service provider, for utilities, fire sprinkler monitoring alarm, landscaping, asphalt maintenance, gate maintenance, exterior lighting, private patrol service (if they choose to contract for one), rubbish removal, etc.
2. Net Lease – Free Standing Building (“Single Tenant”):
Tenant pays Base Rent plus 100% of the property taxes and property insurance.
Let’s take that same building, where for the first year of the lease term the taxes are
$5,000 and the insurance premium is $1,000. The tenant pays that $6,000 per year, or
$500 per month, in addition their monthly Base Rent. In the second year, when the taxes and
Insurance increase by $300, tenant pays the entire $6,300, or $525 per month.
As in a gross lease at a freestanding building, the Tenant is responsible to pay out of pocket, directly to each service provider, for utilities, fire sprinkler monitoring alarm, landscaping, asphalt maintenance, gate maintenance, exterior lighting, private patrol service (if they choose to contract for one), rubbish removal, etc.
3. Gross Lease – Multi-Tenant Building:
The payment structure is the same as in a gross lease in a free-standing building, but the tenant
will also be responsible for common area maintenance (“CAM”) charges, which are similar to association fees in a residential condo.
CAM covers things like commonly metered utilities (often water), fire sprinkler alarm monitoring, landscaping, asphalt maintenance, exterior lighting, security patrols, and rubbish removal. However, the services included in the CAM fees at each service will vary, for example some will include rubbish removal, others will not. In general, the more services the tenant receives, the higher the CAM fee that the tenant must pay.
4. Net Lease – Multi-Tenant Building:
The payment structure is the same as in a net lease in a free-standing building, but the tenant
Will also be responsible for CAM charges (see #3 above).
So to recap:
Single Tenant – Gross: Tenant pays Base Rent + Tax Increases + Insurance Increases
Single-Tenant Net: Tenant Pays Base Rent + 100% of Taxes + 100% of Insurance
Multi-Tenant Gross: Tenant pays Base Rent + Tax Increases + Insurance Increases + CAM
Multi-Tenant Net: Tenant pays Base Rent + 100% of Taxes + 100% of insurance + CAM
A gross lease is not better than a net lease, nor visa-versa. But you need to understand the above so that you can accurately compare apples to apples. Because the net charges can vary so widely from property to property, when comparing two or more buildings, it’s always best to convert any net rent figures into gross rent figures (add taxes, insurance and, if applicable, CAM), so that you are actually comparing the total out-of-pocket costs to lease each building.