A modified gross lease can be best understood through comparison, as it represents a middle ground between a full-service gross lease and a triple net (NNN) lease.
In a gross lease, the property owner is financially responsible for the building, and covers all the expenses associated to its operation (including taxes, insurance, and maintenance). To help recoup some of these costs, the property owner builds them into the monthly rent amount that a tenant pays for use of the building. The property owner pays all of the expenses associated to the building, in exchange for a monthly, all-inclusive rent sum.
Conversely, in a triple net lease, the tenant absorbs all of the operating expenses and property costs into their own business in addition to monthly rent payments, including:
- Property Taxes
- Insurance Premiums
- Maintenance, Repairs and Upkeep
A modified gross lease falls somewhere in between the terms of a gross lease and a triple net lease. In a modified gross lease, the tenant is responsible for some (but not all) of the operating expenses of the property but they still get to pay them as part of one monthly rent amount.
For example, in a modified gross lease, a tenant may be responsible for all the upkeep and maintenance costs as well as certain portion of insurance premiums, while the property owner covers taxes and remaining insurance costs. Modified gross leases are commonly in place on office buildings or other stand-alone buildings.
Gross leases do not require renters to cover any expenses, taxes, or insurance associated to the building, as these will all fall under the responsibility of the property owner or investor. While you can certainly offset all of the building costs, taxes, and insurance by building them into the monthly rental cost, you’ll need to be prepared to handle any expenses that arise on the property which can dent your profit margin if large costs come up unexpectedly.
Advantages of a Modified Gross Lease
Modified gross leases contain details and parameters that are unique to each deal. In general, there’s no set collection of financial responsibilities and how they’re divvied up between the tenant and the property owner. This flexibility can bring advantages for property owners and tenants alike.
- For property owners, a modified gross lease can be attractive because they investor gets to maintain control of important elements of their commercial investment property that they don’t want to entrust fully to the tenants, while covering some of the expenses through tenant rent.
- For tenants, a modified gross lease is advantageous to tenants because they have a location for their business, but don’t have to assume all the expenses and responsibilities of being a property owner.
Drawbacks of a Modified Gross Lease
The terms of a modified gross lease can vary wildly from one deal to another, so it’s important for both property owners and tenants to understand the intricacies and details of any modified gross lease they consider. While modified gross leases have tenant and investor benefits, there are also some drawbacks to consider on each side of the deal as well.
One of the main drawbacks of a modified gross lease for property owners is that they have to assume some to most of the responsibilities (financial and otherwise) of being a landlord. A property with a modified gross lease in place will require more of an investor’s time and resources to manage and they will also have to assume more financial risk due to unknown or unexpected costs that come up when the property needs repairs or work. Whereas in a triple net lease, a property owner has a low-touch, low-risk investment with regular profits over the long term through rent payments and pass through of taxes, insurance, and upkeep costs.
For tenants, a modified gross lease can have some drawbacks as well. A tenant will have to share the responsibility of the building as dictated by the deal, which could expose them to financial vulnerabilities and losses to their businesses if unexpected costs fall under their responsibility. Additionally, tenant will have less control over some aspects of the building that may impact their business in a modified gross lease. For example, if the property owner is responsible for all of the repairs, upgrades, and maintenance of the building, then the tenant doesn’t have control over how their place of business looks and functions, which may create some issues if they don’t agree with changes made by the investor.
While a gross lease can be attractive to renters, it can also present more layers of risk and uncertainty for commercial real estate owners and investors, including:
- Short-term leases
- Profits lost to building vacancies between tenants
- Uninvested tenants
- Unpredictable income streams
- Unexpected tax increases or fees related to the property
Sands Investment Group is a unique team of distinguished net lease brokers and advisors who fully understand the benefits and drawbacks of various lease types and can advise clients on the best deal for their portfolio goals. Our client-focused approach, extensive connections, and marketing expertise are just a few of the reasons we’re the fastest growing net lease investment company in America, closing 1,700 transactions worth $4 Billion since 2010.
Get in touch with a net lease expert today by calling 844.4.SIG.NNN or sending us an email at info@SIGnnn.com.