When it comes to commercial leases, there are various types and terms that can be confusing for both lessors and lessees. Among these terms are “triple net leases,” “pass-through leases,” and “bondable leases,” which may vary in naming conventions depending on the region. Understanding the different commercial lease types is essential for both parties involved. In this blog post, we will delve into the meaning of triple net leases and explore various types of commercial leases to shed light on their characteristics and implications.
Types of Commercial Leases
In broad terms, commercial leases can be categorized based on what is being paid for and how it is paid. Unlike residential leases, commercial leases typically involve more than just a base rent. Let’s explore the primary lease types:
Gross Lease
: A gross lease is similar to renting an apartment for personal use. In this type of lease, the lessor includes all expenses, such as snow removal, lawn maintenance, and hallway lighting, in the rent payment. This is the simplest form of a commercial lease, but it is relatively uncommon in the commercial real estate market.
Triple Net Lease (NNN lease)
: Triple net leases (NNN leases) are frequently seen in retail leases. In this type of lease, the lessee assumes responsibility for additional expenses beyond the base rent. These expenses typically include common area maintenance (CAM), property taxes, and property insurance. The lessee pays the base rent “net” of these three expense categories. Hence, it is called a triple net lease.
Pass-Through Lease
: Pass-through leases, also known as bondable leases, differ slightly from triple net leases. In a pass-through lease, the tenant directly assumes the costs of expenses such as snow removal, landscaping, and property taxes. The tenant reimburses the landlord for these expenses separately from the rent payment. This type of lease is commonly found in freestanding buildings like banks or fast-food restaurants.
Modified Gross Lease
: A modified gross lease is often seen in office buildings, combining elements of both gross and net leases. Under this type of lease, operating expenses, property taxes, and insurance are typically included in the initial base year rent. However, any increases in these expenses over the base year are charged to the tenant based on their pro-rata share. The exact terms may vary, specifying either the actual expenses or an increase over a base amount.
Comparing Commercial Lease Types
Triple Net Lease (NNN Lease) vs. Gross Lease
The key difference between a triple net lease and a gross lease is who covers additional expenses. In a triple net lease, the tenant pays the base rent plus expenses for common area maintenance (CAM), property taxes, and property insurance. In a gross lease, the tenant pays a fixed rent, and the landlord covers all other property expenses. This makes it simpler for the tenant but often results in a higher rent.
Triple Net Lease (NNN Lease) vs. Pass-Through Lease
The main difference between a triple net lease and a pass-through lease is how expenses are handled. In a triple net lease, the tenant pays base rent plus CAM, property taxes, and insurance directly to the landlord. In a pass-through lease, the tenant reimburses the landlord for specific expenses such as property taxes, insurance, and maintenance separately from the base rent. This often results in more transparent cost allocation.
Triple Net Lease (NNN Lease) vs. Modified Gross Lease
The difference between a triple net lease and a modified gross lease is the structure of expenses. Triple net leases have lower base rent with separate additional expenses, while modified gross leases combine elements of gross and net leases. In a modified gross lease, the base year rent includes certain expenses, but any increases in these expenses over the base year are charged to the tenant. This offers a balance between predictability and flexibility in managing expenses.
Commercial Lease Type Implications for Lease Accounting
Understanding the nature of the commercial lease type is essential for proper lease accounting, as it affects how expenses are treated under accounting standards such as FASB, ASC 842, and IFRS 16. While the lease payment represents the amount paid for asset usage, common area maintenance expenses are typically considered variable expenses, separate from the lease component. Taxes are treated similarly, and considered excluded from the lease expense. Lessors should carefully allocate these expenses based on the lease type to accurately report their assets and liabilities.
Navigating the world of commercial leases involves understanding the various lease types available. Triple net leases, pass-through leases, gross leases, and modified gross leases each have distinct characteristics and implications for both lessors and lessees. Familiarity with these lease types is crucial for making informed decisions and ensuring accurate lease accounting. By grasping the meaning of triple net leases and comprehending the differences between commercial lease types, individuals and businesses can navigate lease agreements more effectively and mitigate potential challenges.
