DON’T BE GROSS AND OTHER FUN FACTS ON LEASES
TYPES OF LEASES USED IN RETAIL REAL ESTATE AND SHOPPING CENTERS
There are three basic types of leases used in retail real estate and shopping centers. Since you make an investment in real estate with the expectation of getting more money; the lease types describe how the tenant pays rent and who pays the expenses (i.e. Landlord or Tenant).
The lease types are: Gross Lease, Net Lease and Percentage Rent Lease. The tricky thing about these names is that you can sometimes get a combination of the types in one lease which we will address below.
Gross Lease A Gross Lease is where the Tenant pays only rent and the Landlord is responsible for paying the Real Estate Taxes, Insurance (Property Insurance for the building and Liability Insurance for the common areas) and the maintenance for the Common Areas AND maintenance of the building. It is rare these days to find Gross Leases on Retail Real Estate or Shopping Centers. When you do, it can be a GREAT OPPORTUNITY to add value when the leases come up for renewal. Or a long term Gross Lease can be a landmine as expenses increase exponentially over time and your Net Operating Income decreases to where you cannot pay your Debt Service (mortgage). A Gross Lease is the standard lease that residential landlords often use when renting an apartment. Gross Leases are also found in Office properties and Industrial properties.
Below is an example of a Gross Lease Analysis for Mega Tenant occupying your 10,000 square foot building on the corner of Main Street and Main Avenue in Megalopolis USA. Paying $10.00 per square foot. The expenses increase at 2% per year (because EXPENSES ALWAYS INCREASE).
MichaelJFlight – Gross Lease Scenario.jpeg
Percentage Rent Lease
Most Percentage Rent leases today have a very high Minimum Rent sometimes know as Guaranteed Rent or Base Rent (a term also used with Gross Leases).
With percentage rental, the space is leased at a flat rate against a percentage if the tenant’s gross volume of business. If this percentage exceeds the Minimum or Guaranteed Rent guaranteed rental, the percentage rent is paid on a monthly or annual basis depending on ho the lease is structured. The Minimum Rent remain will remain constant even if the tenant’s sales are so low that no percentage rent would be paid. In the past, stores that did a higher volume of business also had less Gross Margin (less profit on each dollar of sales) so would pay less in percentage rent and less rent as a percentage of sales. For example, supermarkets typically only make three (3¢) cents of profit for every dollar of sales. Stores with a higher markup will typically pay a higher percentage rent rate and a higher percentage of sales to occupancy costs. A jewelry store is a good example of higher profits on each item sold.
The Percentage Rent is calculated by dividing the Minimum Rent by the Percentage Rent rate which will give you the Breakpoint at which the tenant will begin to pay Percentage Rent. This is called a Natural Breakpoint. The formula is: Rent ÷ Percentage Rate = Breakpoint
Below is an example of a Percentage Rent lease analysis for Mega Tenant occupying your 10,000 square foot building paying a Minimum Rent $1.00 per square foot with a Percentage rate of 10% of sales over a Natural Break Point of $10,000. The expenses increase at 2% per year.
MichaelJFlight – Percentage Lease Scenario.jpeg
Usually you will find a combination percentage and triple net lease. This type of lease guarantees not only that tenants will meet tax, maintenance and insurance costs, but also that percentage factors will increase the landlord’s income as the sales volume grows or as the rate of inflation increases.
A Triple Net lease (or “NNN” lease) is a real estate lease agreement where the tenant or lessee is responsible for the ongoing expenses of the property, including Real Estate Taxes, Insurance, and Maintenance, in addition to paying the rent and utilities.
The three major ongoing expenses (other than utilities and mortgage payments) related to owning a property can be placed into one of three categories:
• Real Estate Taxes (Property Taxes)
There are three basic types of net leases, defined by how many of the expense items are paid by the tenant. These items include Real Estate Taxes, Maintenance of Common Area (for example parking lot, parking lot lighting,, landscaping among other items) and Insurance (Liability Insurance for the Common Areas and Property Insurance for the building (the tenant will also carry its own insurance for contents in its premises and liability long with workers compensation)
- Net: (or N or Single Net) The tenant pays base rent plus the Real Estate Taxes.
- Net Net: (or NN or Double Net) The tenant pays base rent plus the Real Estate Taxes and Insurance.
- Net Net Net: (or NNN or Triple Net) The tenant pays base rent plus the Real Estate Taxes, Insurance and Maintenance costs.
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You can use the acronym TIM for the progression from Net (T-axes), Net Net (T-axes and I-nsurance) to Net Net Net (T-axes and I-nsurance and M-aintenance)
The words “net and “net-net-net” are often used interchangeably (if not precisely), because it is generally assumed that a net lease is a triple net lease. In fact, wise retail real estate developers and investor will always try to write a triple net lease to minimize expenses and expense inflation risks. This means the tenant will pay rent per square foot on the space, plus a monthly charge for its share of the property taxes, insurance and maintenance.
Below is an example of a Triple Net (NNN) analysis for Mega Tenant occupying your 10,000 square foot building on the corner of Main Street and Main Avenue in Megalopolis USA. Paying $10.00 per square foot. The expenses increase at 2% per year.
MichaelJFlightTriple Net Lease Scenario.jpeg
Below is an example of a Modified Gross Lease Analysis for Mega Tenant occupying your 10,000 square foot building on the corner of Main Street and Main Avenue in Megalopolis USA. Paying $10.00 per square foot. The expenses increase at 2% per year.
MichaelJFlight – Modified Gross Lease Scenario.jpeg
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LEGAL AND TAX COUNSEL: Concordia Realty Corporation and Michael J. Flight and their affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction or undertaking. Concordia Realty Corporation and Michael J. Flight highly encourage individuals and investors to seek the counsel of a qualified attorney as well as seek the counsel of a tax professional or Certified Public Accountant (CPA) to determine if there are any potential tax liabilities or consequences as the result of anything contained herein. NO GUARANTEE: All users of this website should understand there are NO GUARANTEES of any success, outcome or profitability of any transaction or undertaking, expressed or implied by Concordia Realty Corporation and Michael J. Flight or any of its members, shareholders, officers or affiliates and will NOT be liable for any financial or other losses or damages incurred as a result of any undertaking. Go HERE to view complete DISCLOSURES.
About the Author: Michael J. Flight
Let your investment dreams take flight with the expert help of Michael Flight, principal investor at Concordia Realty.
Michael has worked for more than 28 years and handled more than $500 million worth of real estate transactions on behalf of his clients at Concordia Realty. Michael began his business in the realm of retail real estate, with Concordia Realty now handling third-party property and asset management services for a variety of commercial real estate investments.
He also specializes in revitalizing distressed investments for partners, adding value for clients … including banks, insurance companies, and hedge funds. Michael has consulted for some of the top investment and development companies in the world … and now his knowledge is available to YOU.
Are you searching for someone who can maximize the full potential of your property? Not only do Michael and his team at Concordia specialize in intensive hands-on property management, but they also bring the right relationships with attorneys, consultants, and contractors to the table.
With extensive experience in development, leasing, sales, property management, and innovative financing techniques, Michael and his trained team have the ability to make your property into the cash cow you know it can be.