Types of Commercial Lease

Commercial leases come in various forms, tailored to fit landlords’ and tenants’ unique relationships. These agreements are often shaped by several factors, including the type of business conducted, the nature of the property involved, and the specific terms agreed upon by both parties.

From full-service leases that simplify budgeting for tenants to net leases that incrementally increase tenant responsibilities and to percentage leases that link rent to business performance, the diversity in lease types reflects the complexity of commercial real estate transactions.

By carefully selecting the appropriate lease type, landlords and tenants can ensure that their commercial real estate investments align with their financial goals and operational requirements.

 

Gross Leases

 

Full-service, or gross, leases offer tenants a straightforward rental agreement where most property-related expenses are included in a fixed monthly rent.

Under this arrangement, tenants pay a fixed monthly rent, which encompasses the space they occupy and a wide array of property-related expenses. Typically, the landlord assumes responsibility for most, if not all, costs associated with the property, such as maintenance, repairs, property taxes, insurance, and utility bills.

This type of lease offers tenants a hassle-free approach, freeing them from the complexity of managing and budgeting for various separate expenses. The convenience of a single, all-inclusive rent payment streamlines financial planning and administrative tasks.

However, the ease offered by full-service leases might come at a price. Landlords may adjust the base rent to cover the inclusive services and expenses, potentially leading to a higher overall cost than other lease options. Furthermore, these leases often feature provisions for capping certain expenses or adjusting the rent over time to reflect changes in operational costs, adding an element of financial predictability and flexibility for both parties.

 

Net Leases

 

Net leases present a spectrum of commercial lease agreements, each with varying degrees of responsibility placed on the tenant in addition to paying the base rent. These leases are differentiated primarily by the number and type of property-related expenses the tenant must cover.

 

Single Net Lease

 

In a single net lease arrangement, the tenant’s financial responsibilities extend beyond the base rent to include one specific property expense, typically property taxes. The landlord must handle all other operational costs associated with the property. This lease type is rare in the commercial sector, as it places a more significant burden on the landlord, including the obligation to address maintenance issues at any time.

 

Double Net Lease (Net-Net or NN Lease)

 

A step up in terms of tenant responsibility is the double net lease. Here, the tenant agrees to pay the base rent plus two additional costs: property taxes and insurance premiums. While this increases the tenant’s financial obligations, it often lowers base rent. The landlord, meanwhile, remains responsible for the expenses related to the structural maintenance of the building. This lease type is an intermediary between the less demanding single net lease and the more comprehensive triple net lease.

 

Triple Net Lease (Triple-Net or N Lease)

 

The triple net lease represents the fullest extent of tenant responsibility among net leases. Tenants must cover the base rent and all principal property expenses: real estate taxes, building insurance, and maintenance costs. This arrangement shifts a significant portion of financial and operational responsibility from the landlord to the tenant. While this might lead to lower rent compared to other lease types, it also burdens the tenant more. Triple net leases are favoured in commercial real estate for their potential to offer investors a low-risk, stable revenue stream, as the tenant assumes most of the ongoing property expenses.

 

Percentage Leases

 

This type of lease blends a fixed base rent with a variable component linked directly to the tenant’s business performance. Specifically, tenants pay a portion of their gross sales as additional rent. This arrangement ensures that the rent reflects the tenant’s business success.

To facilitate this, tenants must typically submit regular sales reports to the landlord. These reports help calculate the variable rent component based on an agreed-upon percentage of sales. A distinctive feature of many percentage leases is the inclusion of a “breakpoint” — a specific sales figure that triggers the additional rent payments. Below this sales threshold, the tenant owes only the base rent; above it, the agreed percentage of sales is also due.

 

Absolute Leases

 

Known as an absolute triple net lease, this type transfers nearly all property-related financial obligations to the tenant, making it one of the most tenant-burdened commercial lease agreements.

Under an absolute lease, tenants are responsible for the usual expenses like insurance, taxes, maintenance and significant structural repairs, which are more traditionally the landlord’s domain (e.g., roof repairs).

This lease grants tenants considerable control over the property, including maintenance and operational decisions. However, it also significantly increases their financial risk, as they bear the cost of both minor and major repairs.

Given the extensive financial responsibilities placed on tenants, absolute leases are relatively rare compared to other commercial lease types.

 

FAQ: Types of Commercial Leases in the UK

 

1. What is a full-service (gross) lease?

A full-service lease, also known as a gross lease, is a rental agreement in which the tenant pays a fixed rent that includes most property-related expenses such as maintenance, repairs, property taxes, insurance, and utilities. The landlord covers these costs, simplifying the tenant’s budgeting.

 

2. How does a net lease differ from a full-service lease?

Net leases require the tenant to pay the base rent and one or more property-related expenses, such as taxes, insurance, and maintenance. These leases are categorized into single net leases (tenant pays base rent plus property taxes), double net leases (tenant also covers insurance), and triple net leases (tenant is responsible for taxes, insurance, and maintenance). The main difference from a full-service lease is the increased financial responsibility on the tenant.

 

3. What is a percentage lease?

In a percentage lease, the tenant pays a base rent plus an additional percentage of their gross sales as rent. This type of lease is common in retail and links the rent amount to the success of the tenant’s business. A breakpoint is often used to determine when the percentage rent kicks in.

 

4. Can you explain what an absolute lease is?

An absolute lease, or an absolute triple net lease, places all property-related financial responsibilities on the tenant, including traditional landlord responsibilities such as structural repairs. This gives the tenant greater control over the property and increases their financial risk.

 

5. What are the advantages of a triple-net lease for tenants?

Triple net leases can offer lower base rents since tenants take on more of the property’s operational costs. This can be advantageous for tenants looking for lower initial costs and those who prefer directly managing the property’s expenses.

 

6. How do landlords benefit from percentage leases?

Landlords benefit from percentage leases by receiving a portion of the tenant’s gross sales as rent, which can exceed the amount they would earn from a fixed rent. This aligns the landlord’s interest with the success of the tenant’s business.

 

7. What should tenants consider when choosing between different types of leases?

Tenants should consider their ability to manage and budget for property-related expenses, their desire for rent predictability, and how closely they want their rent tied to business performance. Each lease type offers different advantages and responsibilities, so choosing the right one depends on the tenant’s specific needs and circumstances.

 

8. Are there any specific sectors or businesses that prefer one type of lease over another?

Retail businesses often prefer percentage leases due to the direct link between rent and sales performance. Businesses looking for predictable budgeting might opt for full-service leases, while those willing to take on more responsibilities for potentially lower rents might choose net or absolute leases.

 

9. How are repairs and maintenance handled in different lease types?

In full-service leases, the landlord typically handles all repairs and maintenance. In net and absolute leases, the tenant may be responsible for these costs, depending on the lease’s specific terms. Tenants in triple net and absolute leases often have the most responsibility for property upkeep.

 

10. Is it common for leases to be negotiable in the UK?

Yes, lease terms, including the type of lease, rent amounts, and expense responsibilities, are often negotiable in the UK. Landlords and tenants should seek legal and commercial advice to negotiate terms that best suit their needs.