Modified Gross and Absolute Net Leases, Part II
As described in Part I: “What does Triple Net and Gross Mean?,” a triple net lease means that the tenant is responsible for payment of real estate taxes and operating expenses and the Landlord essentially keeps all of the rent proceeds. However, as is typically the case with industrial leases, the Landlord may take on the responsibility for the roof and structural components of the property. So the Landlord will have some implicit exposure to carrying costs. But in accordance with General Accounting Principles, the actual way a triple net lease is to be handled with regard to repairs, replacements and capital expenditures, the Landlord will bill the tenant for such costs based on the useful life of the item and amortized over the remaining term of the tenant’s lease. So, if an HVAC unit needs to be replaced and this unit costs $10,000, has a useful life of 15 years and there is 3 years remaining on the lease, then the Landlord will bill the Tenant $667 for the remaining 3 years of the term. Capital Repairs and Replacements clauses in leases are often controversial topics and the parties can often benefit by having a professional real estate broker as well as their attorney to advise them.
An absolute lease is one in which the Tenant truly is responsible for all aspects maintaining and operating a property. This will include roof, structural and all mechanical components. An absolute lease is more common in a build to suit deal whereby the Landlord builds and delivers a brand new building for a Tenant. In this scenario, the Tenant starts off with a brand new building and is expected to take on the responsibility to maintain the property appropriately. This is different than an older building whereby the exact condition of the building structure and mechanical systems is unknown. Even if the Tenant completes a pre-occupancy inspection, there is inherent risk in assuming full responsibility.
Leases can also be structured as modified gross arrangements whereby the rent includes some of the operating expenses. So real estate taxes and operating expenses may be included but not the cost for utilities. Sometimes some of operating expenses are included and some are not. For example, all operating expenses may be included but not snow plowing. It is essential for the tenant to fully understand what it is involved before signing the lease and to understand what is and what is not included as well as to obtain a history of operating expenses to understand how efficiently the property is being managed. Also, as stated in Part I, the correct fiscal year for real estate taxes and base year for operating expenses needs to be accurately stated in the lease. Again, your real estate professional should be able to help answer these questions and provide assistance.
Please contact me for further advice on these complex lease issues.
President, Boston Commercial Properties