Types of Leases

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The type of leases you give as well as the clauses contained can make a significant impact on your cash flow.  Here are some common types of leases:

  1. Triple Net (NNN) Lease.  A triple net lease is one where the tenants pay for your operating expenses, such as your taxes and common area maintenance.  For instance, you own a strip mall and charge $28 per square foot + $4.50 per square foot NNN.  If the vacant space were 1,000 square feet, the rent would be calculated as follows: $1,000 square feet * $28 per square foot = $28,000.  This is the rent you collect per year, so on a monthly basis, you would collect $28,000/12 = $2,333 per month.  On top of the base rent, you collect a NNN portion of $4.50 per square foot.  This means you would collect 1,000 square feet * $4.50 per square foot = $4,500 per year, which means you would collect $4,500/12 = $375 per month on NNN.  The total monthly rent you would collect would be $2,333 + $375 = $2,708.  As you can see, the NNN portion of $375 per month pays for your operating expenses.
  1. Gross Lease.  In contrast with a triple net lease, the landlord pays for his or her own operating expenses.  In the example above, the rent would simply be $2,333 per month, since there is no NNN portion.  However, since the landlord pays for the operating expenses, you can typically charge a higher rent per square foot. 
  1. Percentage Lease.  Percentage leases are common in shopping centers, where the landlord demands a percentage of the revenues of the business as rent.  For instance, you might charge a base rent of $2,000 + 3% of sales over $30,000.  If your tenant generates $29,000 in revenues for the month, the rent would be $2,000.  However, if your tenant generates $40,000 in revenues, you charge 3% of any additional revenues over $30,000 as additional rent.  In this case, the tenant makes $10,000 more than $30,000, which means you get 3% of $10,000 as additional rent, which amounts to $300.  Your rent for the month would be $2,000 + $300 = $2,300. 

In addition to the type of lease you have, the clauses contained can also affect your cash flow.  You may stipulate in the lease that rents will automatically go up by 3% each year.  You may tie the rent increase to a cost of living index, such as the CPI.  Potential tenants may try to negotiate improvements or a month or two of free rent if they sign a long-term lease. 

In commercial leasing, remember that a bad situation on the surface may actually turn out to be good.  Suppose you sign a 5-year lease, and 2 years into the lease, the tenant goes out of business.  You can negotiate a lump sum payment to let the tenant off the hook.  By finding a new tenant who signs a new 5-year lease, you have extended your cash flow by 2 more years starting at the current market rent. 

Another example is the tenant wanting to make improvements.  You can let the tenant know that since the premise is being customized to fit their business, you would want to make their lease longer, which gives you more years of cash flow.  Remember that the lease is a living document.  Just because you have a signed lease does not mean it is set in stone.  Every time the tenant makes a request, you can negotiate to modify the terms of the lease to make the situation more favorable. 

Comments (2)

Michael A. Caruso
Surterre Properties - Laguna Niguel, CA

Hi Aaron,

Nice post - very good explanation.  Have a great week.  Michael A. Caruso

Apr 02, 2008 11:10 AM
Michael Setunsky
Woodbridge, VA
Your Commercial Real Estate Link to Northern VA

Aaron, good explanation of the various types of leases.

Good Post!

Apr 03, 2008 03:07 AM