The primary objective of any real estate investment is to achieve optimal cash flow from the property. This cash flow, or net income, is the revenue remaining after all related expenses have been accounted for. To accurately assess the revenue and expenses of a real estate investment, it is essential to understand the different types of leases in real estate.
Before diving into the types of leases, it’s important to understand the different types of expenses to better comprehend how leases work. In real estate, expenses are generally categorized into operating expenses and non-operating expenses.
Operating expenses are the costs incurred for the day-to-day operations and include items such as property taxes, property insurance, management fees, repairs and maintenance, common area maintenance, security fees, landscaping, and utilities like water, sewer, and electricity.
On the other hand, non-operating expenses include capital expenditures, interest expenses, and depreciation, which are not directly related to the property’s day-to-day operations.
Now, moving on to the types of leases, there are three main categories: Triple Net Lease (NNN), Modified Gross Lease (MG), and Gross or Full-Service Gross Lease. These leases are classified based on their expense structures.
Triple Net Lease (NNN)
A Triple Net Lease, also known as a Triple-Net or NNN lease, is a type of lease agreement where the tenant is responsible for covering all expenses, including property taxes, property insurance, and maintenance charges. The landlord collects a base rent for the premises and is also reimbursed by the tenant for these expenses. In this arrangement, the tenant pays a fee, often a prorated share of expenses such as property taxes, insurance, and other service costs.
There are also other variations, such as the Single Net and Double Net leases, where the tenant takes responsibility for one or two of these three obligations, in addition to paying the base rent.
Absolute Net Lease
Similar to a Triple Net Lease, an Absolute Net Lease passes expenses on to the tenants. The key difference is that while a Triple Net Lease typically includes three main expenses—property taxes, insurance, and maintenance—in an Absolute Net Lease, all expenses, including repair and maintenance of the structure and roof, are the tenant’s responsibility. In other words, with an Absolute Net Lease, the tenant covers all expenses, and the rent collected by the landlord represents the property’s net operating income.
Modified Gross Lease
A Modified Gross Lease (MG) lies between a Triple Net Lease and a Gross Lease. In this arrangement, both the landlord and tenant share responsibility for operating expenses. The tenant pays rent that encompasses some of these expenses, while the landlord takes care of others. For instance, the tenant may be responsible for utility costs, while the landlord pays for insurance and property taxes. The precise allocation of expenses is usually negotiated between the landlord and tenant.
Gross Lease
A Gross Lease is a lease agreement where the landlord assumes responsibility for all operating expenses, such as property taxes, property insurance, and common area maintenance. The tenant pays a fixed rent, which enables them to accurately predict their expenses. While fluctuations in operating costs do not impact the tenant, they may face higher rent, as the landlord includes anticipated expenses in the overall rent amount.