MJF006 Don’t Be Gross and Other Fun Facts on Leases

by Michael Flight

07.03.2018

A picture of the Mirage Resort and Casino in Las Vegas Nevada USA along with the famous volcano on a sunny morning. The Mirage is owned by a REIT as a net lease property.. Photo credit Michael Flight all rights reserved

Don’t Be Gross and Other Fun Facts on Leases

This article was originally published on www.concordiarealty.com on July 3, 2018.

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).

Gross rent senario

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.

Percentage

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.

Net Lease

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)
•    Insurance
•    Maintenance

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)

  1. Net: (or N or Single Net) The tenant pays base rent plus the Real Estate Taxes.
  2. Net Net: (or NN or Double Net) The tenant pays base rent plus the Real Estate Taxes and Insurance.
  3. Net Net Net: (or NNN or Triple Net) The tenant pays base rent plus the Real Estate Taxes, Insurance and Maintenance costs.

 

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.

TripleNet

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.

ModifiedGross

MichaelJFlight – Modified Gross Lease Scenario.jpeg

“You are rewarded not according to your work or your time but according to the measure of your love.”  St. Catherine of Siena

Michael J. Flight

Principal at Concordia Realty Corporation
CEO & Co-Founder of Liberty Real Estate Fund
Co-Founder & Chief Strategy Officer of Invest On Main
Co-Founder of Blockchain Real Estate Summit

Michael J Flight was named the Godfather of Blockchain Real Estate by Forbes Crypto Editor Dustin Plantholdt. Michael achieved that distinction by co-founding Liberty Real Estate Fund, the World’s First Net Lease Security Token FundTM and creating the Blockchain Real Estate SummitTM. More recently, Michael has co-founded Invest On Main (IOM.ai) the Real Estate & Alternative Asset marketplace of the future and AcceleratedLaw a faster, more affordable way to create and tokenize securities offerings!

Michael is a real estate entrepreneur and real estate tokenization pioneer who is an expert in retail real estate investment, redevelopment and real estate on the blockchain. He started his commercial real estate career in 1985, and then co-founded Concordia Realty Corporation in 1990, which continues to partner with some of the world’s most well-known banks, insurance companies, hedge funds and institutional investors in many successful investments.

Michael is a real estate entrepreneur and Blockchain Real Estate evangelist who is an expert in retail real estate (Shopping Centers and Single-Tenant Net-Leased) investment, redevelopment and real estate on the blockchain. He has an extensive record of value-add shopping center redevelopment and with partners Merchant Equity Group, LLC as a pioneer in de-malling (repurposing enclosed malls). Michael has been active in commercial real estate over the past 35 years.

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