If you are a commercial real estate investor who owns a triple net (NNN) property, you most likely benefit from a corporate lease with a high-credit tenant and many landlord benefits, including a long-term, safe, responsibility-free income and the peace of mind that comes with it. But what if you’re considering investing in a property that’s not a NNN lease? Then, most likely, you will have either a gross lease or a modified gross lease.
What is a Gross Lease?
A gross lease, which is sometimes referred to as a full-service lease, is a commercial lease commonly used with multi-tenant properties, industrial, and some retail properties. In a gross lease, the property owner/landlord pays all expenses, including property taxes, insurance, operating, and maintenance expenses then calculates one rental amount that covers all the monthly costs. Each tenant then pays a flat-fee base or “gross” rent, which includes a pro-rated or “pro-rata” share of those expenses.
In a gross lease, the property owner pays all of the following, then estimates a flat-fee rent for each tenant that covers these costs:
- Operating expenses
- Property taxes
- Management costs
One of the risks with a gross lease, aside from the high level of daily responsibility and potential capital outlay, is that it’s difficult to estimate accurate expenses without historical data or if the tenant is new and you have no idea what kind of consumption or needs will be presented. If a tenant moves into a space that uses more electricity or water than the previous tenant, you could be stuck paying the excess charges.
Moreover, when locked into a long-term gross lease, expenses can increase significantly over time and you may be left paying the difference until the lease comes around for renewal. Once you factor in all the expenses, time investment, and unknown factors, an advertised 10–12% return could end up as a realistic 5–6% internal rate of return (IRR).
What is a Modified Gross Lease (MGL)?
A modified gross lease (MGL) is often used for office complexes and retail centers where there are many tenants, as well as some single-tenant units leased by national corporations, such as AutoZone or Starbucks. A modified gross lease usually includes customized lease terms that simply “modify” a gross lease, whereupon the property owner and tenant share costs.
In a typical modified gross lease, each tenant pays a portion of the net operating costs directly related to the real estate – usually utilities, maintenance and/or CAM, minor repairs, security, and janitorial services. An MGL can require the tenant to pay the designated costs directly to the supplier charging the fees or it could state that the tenant pays a portion of the expenses directly to the landlord in addition to rent. Typically, in a modified gross lease, the property owner/landlord pays building maintenance and structural costs, as well as the real estate taxes and insurance.
In a modified gross lease, the property owner and each tenant typically share a portion of operating costs, such as:
- Common area maintenance/small repairs
- Janitorial costs
- Building maintenance
There are a few more landlord benefits with a modified gross lease than a gross lease, namely, the reassurance that the building is being taken care of in an agreed-upon manner with fewer expenses and less likelihood of tenant conflict when it comes to maintenance. However, with a modified gross lease, an advertised 10–12% return could amount to a 6–9% IRR, depending on the lease agreement and expenses.
What is an Absolute NNN Lease?
A triple net (NNN) lease property is an investment in which the tenant agrees to a long-term lease that requires paying the “net” amount for three types of costs – net real estate taxes on the leased asset, net building insurance, and net common area maintenance. Most often, these tenants are investment-grade corporations such as Dollar General, Walgreens, or Taco Bell.
These multibillion-dollar companies choose to take a traditional triple net lease to the next level and operate with an absolute NNN lease because they want control of all aspects of the property for uniformity across their brand. In addition to the net taxes, insurance, and common area maintenance, they perform their own building maintenance, pay for all capital expenditures, and assume all financial risk. The landlord is responsible for nothing.
In an absolute NNN lease, the tenant assumes responsibility for every possible financial risk, including:
- Real estate taxes
- Common area maintenance
- Building maintenance
- Capital expenditures
- Operating expenses
As the investor, when you own NNN properties, you are protected from unpredictable and rising operating costs, leaving you completely free to carry on with life and collect monthly income for 10–20 years with zero responsibility. By the time you factor in tax opportunities and incremental rent increases over the lease term, an advertised 5.00% cap rate on an absolute NNN could ultimately amount to an easy 7–10% internal rate of return.
Understand Different Lease Types Before Buying
It’s important to understand the different lease types available and the expenses associated with them when searching for your next real estate investment.
In a gross lease or modified gross lease, tenants pay their pro-rata share of expenses but they will not pay for anything above that, so if you own one of these properties, you are doing a lot of work and spending your capital, which leads to an overall lower ROI.
In a double net lease, typically the tenant will only pay for the net amount for two of the three things: taxes, insurance, and/or CAM, and may also pass along other expenses to the landlord, such as roof and structure. If you don’t mind a modified “somewhat hands-on approach,” there are some national corporations like DaVita and O’Reilly Auto Parts that only offer NN leases but offer the benefit of being credit-worthy, reliable, long-term tenants who pay handsomely for the privilege to lease a sound building in a prime location.
In a modified triple net lease, the tenant will still pay the net taxes, insurance, and CAM, but may pass along roof and structure costs to the landlord. Starbucks is a prime example of a modified NNN lease.
In an absolute triple net lease, the property owner receives a 100% responsibility-free monthly check for ten to twenty years from a multibillion-dollar, reliable, credit-worthy tenant with periodic rent increases, no maintenance responsibilities, and a solid 7–10% IRR. If this sounds favorable, then this type of CRE investment is for you.
Thank you, Westwood Net Lease Advisors, for allowing me to sleep at night. I sold my four-family flat and obtained a great national company, Dollar General, which sends me one check a month. I no longer get calls from tenants. I spend my time playing golf instead of listening to their complaints. You guys are terrific.” – M. Overly, Florida
To Wrap It Up – Gross Lease, Modified Gross Lease, or NNN Lease?
As you contemplate your financial goals and how active you want to be in your next commercial real estate investment, or if you are new to the CRE market, the various lease types play a major role in how involved you will be in the day-to-day management and, ultimately, your cash flow and IRR.
Not sure where to start? Engaging a trusted Westwood Net Lease Advisor makes for a smooth process whether you choose a gross lease, a modified gross lease, or a NNN lease property. We have decades of 1031 exchange and NNN investment expertise and work with buyers and sellers all over America. We offer buyers objective advice, education, knowledge, and advocacy from before the property search through closing – all without any cost to you! Contact us today for a free, no-obligation conversation. 314-997-5227.