UNDERSTANDING RENT, LEASE TYPES, AND ADDITIONAL RENT
By: Jeffrey Lerch, CPM
The concept of “Rent” includes Base Rent and Additional Rent. Base Rent is the amount of consideration payable by a tenant for the right to posses the subject premises. However, the type of lease quoted can mean a significant difference in the total money paid to the landlord each month. The typical lease types are most commonly: Full Service Gross (FSG), Modified Gross (MG), Industrial Gross (IG), Net (N), and Triple Net (NNN). Each type refers to the landlord’s ability to administer certain charges in addition to Base Rent. These amounts, known as Additional Rent, include other monthly charges, which can be a hefty amount for the unsuspecting tenant. Additional Rent charges may include a combination of any of the following:
- Operating Expenses
- Property Taxes (landlord’s)
- Insurance (landlord’s)
Certain lease types are often used for specific property types. For example, NNN leases are commonly used for retail, or single-tenant facilities, whereas IG and MG are commonly used in multi-tenant industrial applications.
FSG leases are used almost exclusively for multi-tenant office leases. Notwithstanding these conventions, there is nothing that requires a landlord to use one lease type or another. In fact, there are many examples of landlords quoting MG or NNN rent for multi-tenant office buildings, which further highlights the need for proper due diligence during lease negotiation.
DIFFERENT LEASE TYPES
Lease types are generally defined as follows:
- Full Service Gross (FSG): Under an FSG lease, Base Rent is inclusive of all building operating expenses, Property Taxes, and Insurance. The landlord provides utilities and janitorial service as a part of the operating expenses. The tenant pays no additional fees until the total building expenses exceed a base amount, which can be defined as a Base Year or Base Stop. FSG leases are typically associated with multi-tenant office transactions and are quoted as Base Rent only.
- Modified Gross (MG): In a MG lease, Base Rent typically excludes utilities, janitorial, and sometimes trash and tenants are required to contract for these items separately. Similar to FSG, the tenant pays no additional fees until total building expenses exceed a base amount, which can be defined as a Base Year or Base Stop. The landlord is responsible for the maintenance of all common areas and structural building components, but the Tenant must maintain certain matters within the leases premises. MG leases are frequently associated with multi-tenant industrial, industrial, or certain office lease transactions and are quoted as Base Rent only, which means that the tenant must consider these other leasehold costs during negotiation.
- Industrial Gross (IG): Same as MG above.
- Net (N): Same as MG and IG above, with the exception that the Base Rent is quoted as “net” of one or more expenses, such as electrical or janitorial. For example, a building that is quoting a rent of $15 per square foot net electric, means that the tenant will have to pay for electricity costs in addition to rent.
- Triple Net (NNN): In addition to Base Rent, tenants must pay for its proportionate share of all building Operating Expenses, Taxes, and Insurance. The tenant must also contract separately for utilities, janitorial, and trash service. Depending on the nature of the transaction, either Landlord or Tenant is responsible for specific maintenance items. When used in an industrial lease, the tenant is responsible for all maintenance, including landscaping, painting, exterior lighting, parking lot, and structural items (roof, foundation, etc). When used in an office lease, the landlord will typically maintain all common areas and pass these costs on to the tenant in accordance with Tenant’s proportionate share. Rents are quoted as Base Rent plus NNN fees (ie: NNN fees $0.39 psf/month). In some instances, tenants must also remember to consider the additional leasehold costs of utilities, janitorial, and trash during negotiations.
WHY DIFFERENT TYPES OF LEASES?
So you may be asking “Wouldn’t it be simpler just to use one type of lease?” Not necessarily. In fact, there are often very practical reasons to use one form of lease over another. Large industrial leases are often NNN, with the tenant responsible for all expenses, maintenance, and utilities. Administratively, it is much more efficient for both parties to charge Base Rent only and let the Tenant contract all other items. The lease will obligate the Tenant to perform certain levels of maintenance in order to preserve the structural and aesthetic nature of the property.
Compare this with a multi-tenant office building where all maintenance is performed by the Landlord, including janitorial. Administratively, it is easier for all electrical to be on a single meter since spaces can be split or combined depending upon the size of premises required. Cleaning quality is enhanced by having only one janitorial contractor in the building, as is the safety and security for all Tenants (can you imagine having 50 different janitorial companies in a building?!) In this case, a FSG lease would be appropriate, with the Landlord taking responsibility for the administration of these building matters.
There are other factors that can drive the decision of which type of office lease to use. Landlords may choose to adopt a specific lease type for the sake of their own administrative convenience. The fact that a landlord has a large national NNN portfolio might make it easier for them to discuss rents across all properties consistently if they administer each and every lease agreement as NNN rather than having multiple lease types.
Geography may also have a bearing as to what types of office leases are conventionally used in a given market. For example, office buildings in Los Angeles are frequently quoted as NNN leases, whereas offices in Orange County (just 30 minutes away) are quoted as FSG. It is much simpler for tenants to understand quoted rents if all landlords are asking for the same thing. For this reason, a landlord with a large national portfolio of NNN leases may find it easier to compete in a FSG market by following local convention rather than his local portfolio standards.
COST COMPARISON OF LEASE TYPES
At first blush, it might appear that the NNN lease is a better deal than the FSG lease. However, the total cost of each lease type is the same. This is due to the fact that the difference in lease types merely shifts the financial liability from one party to another. It does not, however, grant a landlord the ability to increase his total billings merely based on the type of lease used. Landlords compete for tenants in an open market, which means that their total costs must be competitive. Consider the following comparison of lease rates for a suburban office building.
|Building A||Building B||Building C|
|Base Rent||$30.00 psf/yr||$27.00 psf/yr||$20.16 psf/yr|
|Total Rent||$30.00 psf/yr||$30.00 psf/yr||$30.00 psf/yr|