There are several operating expenses associated with commercial space which tenants may or may not need to pay in addition to base rent.
Operating expenses generally include property tax, insurance, maintenance (or CAM), and utilities. Depending on the expense reimbursement structure in the lease agreement, the tenant might be responsible for none, some, or all of these operating expenses.
While there are slight variations on each of these, commercial leases typically fall into one of three buckets: net, gross, or modified gross.
What is a net lease?
A net lease essentially means the tenant is responsible for the property’s operating expenses. However, there are variations of net leases, including absolute net, triple net (NNN), and double net (NN).
In an absolute net lease, the tenant is responsible for everything; the tenant pays the property taxes, insurance, and all maintenance (both structural and non-structural). The landlord has zero operating expense responsibilities, and the tenant often pays everything directly. Absolute net leases are fairly typical for outparcels within shopping centers (e.g. fast food restaurants), where the tenant may have even constructed their own building and has complete control over their portion of the center.
By definition, triple net (NNN) means net of taxes, insurance, and maintenance, as in the tenant is responsible for these costs. It’s similar to absolute net, but with some important distinctions.
While the exact definition tends to vary by region (or even by person), I’ve found that NNN most often means the tenant is responsible for taxes, insurance, and non-structural maintenance (essentially everything but capital expenditures). This means that while the tenant is responsible for most operating expenses, the landlord may still be responsible for items related to the structure and/or exterior, such as the roof or possibly the parking lot.
This is where it gets a bit fuzzy and often requires clarification. Double net (NN) means net of taxes and insurance. In my experience, the tenant usually still has some maintenance responsibilities in NN leases, but the landlord is responsible for at least structural and exterior repairs, if not all maintenance.
What is a gross lease?
In a gross lease, aka full service (FS) or full service gross, the tenant does not pay any operating expenses, as the landlord is responsible for all real estate taxes, insurance, maintenance, and utilities. Depending on the property type and situation, this could include services like janitorial are also included in the base rent and provided by the landlord.
While traditionally ‘gross’ or ‘full service’ means the landlord pays all expenses, sometimes the tenant pays for their own utilities, for example, and the parties involved still refer to the agreement as a gross lease. I would argue that’s modified gross, but these terms are often subject to interpretation.
What is a modified gross lease?
A modified gross (MG) lease is somewhere in between a net lease and a gross lease, meaning the tenant and landlord each have some operating expense responsibilities.
Under the modified gross umbrella, a fairly common structure for multi-tenant industrial leases is the industrial gross (IG) arrangement. In industrial gross leases, the landlord is typically responsible for base year real estate taxes and insurance (BYS), while the tenant pays for utilities and services like janitorial, if needed; sometimes the tenant is also responsible for non-structural maintenance.
BYS (base year stop) means that the landlord is responsible for the expense up to the base year amount (Year 1 of the lease) and the tenant pays the excess above that amount in future years.
For example, let’s say the property insurance cost was $0.25 per square foot in the first year of a multi-year lease and it increases to $0.30 per square foot in Year 2; the landlord would be responsible for paying the $0.25/sf base year amount, and the tenant would pay the excess $0.05/sf.
Summing It All Up
The following table outlines which party is typically responsible for the different operating expenses. Keep in mind, there’s not really a universally accepted definition for each of these terms, so the most important thing you can do is make sure you fully understand the lease despite whatever term is used to informally describe the reimbursement structure.
* MG: the tenant and landlord share various operating expenses
** BYS: the landlord pays the base year expense and the tenant pays any increases above the base year
*** FS/Gross: the landlord might also provide services like janitorial, landscaping, etc.