Gross Lease vs. Net Lease: How to Decide

Finding a location and negotiating a lease is a crucial early step in the formation and growth of a business. Whether you choose a gross or net lease is an essential decision in that process.

Most commercial real estate leases are very different from the residential leases that many people sign during their lives. Residential leases are largely non-negotiable at a fixed rent amount. You pay the actual rent the landlord demands, and you sign the lease, accepting the terms the property owner has outlined.

Negotiating commercial lease agreements is much more of a give-and-take scenario, including not only how much the payment will be but also how every part of the lease will be structured. Besides deciding the type of lease, you consider how the property can be used and who will pay for what. That includes whether the tenant or the landlord covers big property expenses like utility costs, property taxes, and insurance costs, plus additional expenses.

Within the two categories of commercial leases—gross lease and net lease—there are plenty of options for negotiation. The landlord and the potential tenant sit down and hash them out. These negotiations can be very complicated, but having a business attorney on your side will help you secure the best terms.

Start with the basics

The base rent in commercial lease structures is the cost per square foot multiplied by the square footage of the rental space. How the landlord measures that space can be key. Does the landlord include the hallway? What about the stairwell? Unless you have a sharp eye for this kind of detail, hiring an attorney to help define the rental area can save money on the fixed rent amount before you get to the rest of the details.

Next, consider how other essential and variable property-related costs will be paid. These include utilities, property taxes, insurance costs, and maintenance. How will tenants and the landlord share costs for the building’s common areas, including parking, lobbies, landscaping, restrooms, and additional expenses? Will the landlord pay for building maintenance or split costs with the tenant, or will the tenant pay the entire cost of property upkeep and other building expenses?

These are bottom-line issues, and the answers to these questions will lead you to decide the kind of lease you’re willing to sign and how that lease should be structured.

What is a gross lease?

In a gross lease, the tenant pays only the base rent. The landlord is responsible for paying for everything else. In many cases, the rent will be substantial, reflecting the landlord’s costs, but the tenant will pay very little above that agreed-upon rent, if anything at all. This kind of predictability can be good for a small or startup business.

This could be the lease for you if you’re a new business, and you don’t know whether the location is right or even if your business will survive. You probably can negotiate a short-term gross lease with the right of first refusal to renew. This gives you some stability plus a little wiggle room. You can get out of the lease quickly if you need to, or if things go well, you can renegotiate for a lease that will serve your growing company better.

What is a net lease?

Signing a net lease is a lot like buying a property. The lease payment includes the base rent plus at least one of these categories: property taxes, maintenance, and insurance.

In a single lease (N), the tenant pays base or fixed rent plus one of the cost categories. In a double net lease (NN), the tenant pays the base rent plus two of these categories. In a triple net lease (NNN), the tenant pays base rent and all three categories of costs.

Triple net leases are most common in longer leases—10 years or more. They are particularly common in leases of retail spaces or office rentals where the tenant will control the entire office building.

Gross lease vs net lease: Full comparison

Here are some things to consider about gross vs. net leases. Understanding these essentials is important, even if you have a good attorney on your side.

Key differences between gross and net leases

• A tenant with a net lease agreement pays a reduced base rent compared to a gross lease, a reduction that should be big enough to offset the cost of paying the other expense allocations.
• Gross leases are generally for small spaces. Net leases, triple net, in particular, are often for entire office buildings.
• Gross leases free a tenant from unpredictable operating costs, although modified gross leases can assign some of those operating expenses to the tenant. For instance, in modified gross leases, tenants can be responsible for paying some of the utility costs or insurance costs but not others. In deals relying on modified gross leases, tenants and landlords must agree on how operating expenses will be paid. Will the landlord pay everything and recoup the costs from the tenant, or will the tenant be responsible for paying directly?
• Because net leases come with lower base rent payments, the tenant has more control over the other costs. In a building that has been well managed, maintenance and even property tax costs will be lower, and the tenant can work to keep them that way.
• A tenant with a triple net lease can sublease parts of the building that the company doesn’t need at the moment. Those subleases will further reduce the operating expenses.
• Using a savvy lawyer can make a difference in any real estate negotiation, but net leases—single net leases, double net leases, or triple net leases—are especially complex, making involving a lawyer very important.

Gross lease pros and cons

In some cases, choosing a gross lease makes perfect sense and can be a big advantage. The tenant pays rent. That’s about it. Other times, no matter how simple it seems, a gross lease can cost you. Here are some decision points:

Pros

• Gross leases provide predictable rent payments that cover day-to-day expenses associated with renting commercial properties. Budgeting is easier with a gross lease because unexpected operating costs are unlikely to pop up—at least not without some warning. This can be important for entrepreneurs and start-ups with limited cash flow.
• From a landlord’s point of view, gross leases are simple for potential tenants to understand. That can make it easier for a landlord to attract a new tenant.
• At the same time, a tenant isn’t usually locked into a long gross lease, so if the tenant’s needs change—the business grows fast or doesn’t do well and needs to be shut down—having a gross lease that is easy to exit can be good.

Cons

• For a tenant, lack of financial control is the main drawback. Landlords who fully service leases can increase rent—sometimes by a lot—and the tenant doesn’t have much recourse.
• Costs related to property taxes and insurance can skyrocket. There are tactics that can be employed to help keep these operating expenses under control, but they usually cost money upfront. A landlord with a full-service lease or other gross lease doesn’t have much motivation to spend money on lowering operating expenses.

Net lease pros and cons

While net leases are a bit more complex, they work well for some businesses. Here are factors to keep in mind.

Pros

• Triple net (NNN) leases are very common and popular. Tenants like them because they offer the ability to customize the space to meet all kinds of needs.
• If the space is too big, the tenant can subdivide and use the income from that rental fee to pay part of the operating expenses
• With help from a savvy tax adviser, a tenant can deduct property taxes and take the insurance costs as business expenses.
• From a landlord’s standpoint, triple net or even double net leases offer steady income without much work. With a good tenant, the cash just keeps flowing.

Cons

• Maintenance costs can be a challenge for both landlords and tenants. If the building is in good condition, maintenance costs won’t be high, and the tenant benefits. But if there is a need for expensive and unexpected repairs, the tenant can face business-threatening operating expenses.
• While the landlord might be off the hook because they don't pay maintenance expenses, this can backfire. A tenant who wants to avoid big expenses can scrimp on the repairs or simply hide them until the costs have mounted and the lease has ended.

How to choose the right commercial lease type

The lease type you should choose is the one that will offer your business the greatest opportunity for success. Consider these factors:

If you’re a young company, then a gross lease may serve you well because it will provide more financial predictability. A gross lease is also easier to understand. If you’re not ready for a long-term lease and its financial burden, a gross lease could be the right answer.

A net lease, with its many permutations, requires business sophistication. Companies that have stable cash flow and the ability to manage real estate along with managing their other business are the best candidates for net leases, especially triple net leases or their stricter cousins, absolute net leases. Signing an NNN lease is akin to buying a property. You’ll be committing to a long-term lease—at least 10 years—and taking on the expense of maintenance and uncertain insurance fees. Meanwhile, the landlord is responsible for very little.

But if you are a major retailer or a large service company, for instance, a net lease, especially a triple net lease, can give you control, lower monthly costs, and low overhead, along with the ability to keep it that way. The fact that the landlord is responsible for very little is a good thing.

Before you make decisions about gross and net leases, talk to a lawyer who understands these issues and who can carefully read a lease and identify problems.

5 reasons to consult a commercial lease attorney

While not legally required, it is highly advisable to engage an attorney who specializes in this field when entering into a commercial lease. Here are the top reasons: 

Commercial lease attorneys have negotiation skills

A commercial lease is going to be one of the biggest costs your business will incur. It’s important to not only get the best rate but also lease terms that protect you from unreasonable demands, including increases in the rent that go beyond what could be reasonably expected. Attorneys who specialize in commercial leasing deal with such leases daily. They know what provisions are good for your business and which ones aren’t. They understand what the landlord is responsible for and how those obligations should be structured.

From a landlord's point of view, a smooth-running tenant relationship will make your business and your life run more smoothly. And in the long run, you'll make more money.

Clarity: You understand what you are signing

Commercial leases can be full of legal jargon. Anyone not well versed in this field of the law can get lost in the technical terms. A knowledgeable attorney can also identify loopholes and ambiguous clauses that could leave you vulnerable.

You get key risk and dispute management advice

While we would all hope that the relationship between the landlord and the tenant is positive, it is wise to recognize that disagreements happen. A commercial real estate property attorney can ensure that the lease includes provisions protecting the rights and interests of both parties. They can review the dispute resolution process and ensure it includes options that in the case of a dispute are fair to both sides.

Compliance and due diligence knowledge is vital

When you sign a lease, you must comply with state and local regulations, including zoning laws, building codes, and specific regulations that apply to your industry. Some of these rules can be hard to understand or easy to overlook. An experienced attorney can walk you through the requirements and make sure that the lease complies.

Expertise saves you money and gives you an exit strategy

If something goes wrong, you need a way out. An attorney can help you understand the consequences of things you hope will never happen. The attorney can negotiate terms that allow for flexibility if things don’t go as planned and the business has to relocate or close. In the long run, this is reason enough to hire an attorney with commercial real estate expertise.

FAQs

Can you negotiate the terms of a gross or net lease?

Yes. This is not an apartment lease. You can negotiate every part of a commercial space lease. Hiring an attorney to do this for you is particularly important because a lease is often the most significant overhead a new business pays.

Are there hidden costs in gross or net leases?

Absolutely. A big gotcha in gross leases is office lease expense caps. The landlord pays all the expenses up to a certain amount. After that, you pay. It is an easily misunderstood and overlooked clause. In the case of triple net leases, things called “administrative fees” get tacked on. You end up paying everything plus a surcharge. These are by no means the only hidden costs. This is why you need an attorney to help you negotiate your lease.

Is a monthly lease better for new businesses?

A monthly lease leaves a new business with enormous uncertainty. It can result in a landlord raising the rent a punishing amount. It can also mean the landlord can terminate the lease with little or no warning. It could result in your company losing any improvements you might have made to the property. Also, banks don’t like month-to-month leases, and should you apply for financing to expand your business or become a property owner, you may be denied because you don't have a stable lease. 

Why is leasing better than buying?

Buying gives you more control over your property, but it ties up your capital. It can leave you owning a property that no longer meets your needs. This topic requires significant analysis. Talk to both your lawyer and your accountant before you make this big commercial real estate decision.

What is the one thing a potential tenant should do?

Find a knowledgeable commercial real estate attorney who will work with you to negotiate the best lease deal possible.