Not too long ago a client of mine, who was a coworking operator, approached me about taking more space in one of the hottest submarkets in Dallas–Fort Worth (DFW). Fortunately, my client had been an early adopter of coworking and secured an extremely low gross rental rate (pre-gentrification). Unfortunately, the market had caught up to them and gross leases were a thing of the past.
After preparing to burst my clients bubble I went to show them an expansion option in the same building. The building they had been in was recently purchased by a big time institutional investor. During a meeting in one of his conference rooms, my client pointed to the newly proposed lease rate. $22.00/RSF “not too bad” he said. I proceeded to point out the three NNN’s following the number and got no reaction from him. It occurred to me my client had no idea what the difference between a gross lease and a NNN lease was at all.
So, for those who are still struggling with the differences between the two lease structures; here they are—short and sweet.
A gross lease means you are paying basic rent plus either your pro-rata share of Electricity & Janitorial expenses or your electricity and janitorial as used (assuming they are independently metered or you are in a single-tenant building). In a gross lease you have a “base year” which is an annual operating expense statement that establishes the amount of operating expenses that you do and do not have to pay for. The base year shields you from paying anything in operating expenses in subsequent years unless that number is greater than the base year you chose (this makes picking which year you use for your base year important in negotiation but we’ll save that for another day). Ideally, your broker or attorney will put a cap on how much you would have to pay assuming there are any overages beyond your base year (this is a good thing).
In a NNN lease you pay basic rent plus your pro-rata share of ALL of the building’s operating expenses. This means you are paying your share of taxes, insurance, maintenance, landscaping, the cost of management offices, and almost everything else apart from capital expenditures. The problem with a NNN lease is it almost always affords the user less control. Even if your attorney or broker negotiates to cap controllable expenses, this actually only provides minimal protection from expense pass-throughs.
In the case of my DFW coworking client’s expansions, the NNNs (additional operating expenses) on his expansion alone would have grown by $2.12/SF from 2015 to 2016 had he taken the offer. This may sound like a small number but think of it in coworking terms. For my client that uncontrollable expense growth is the equivalent of his Community Manager’s salary plus the cost of a year’s supply of Starbucks K-Cups for his community Keurig machine!
Additional Points on NNN Leases:
- Gross leases are almost always better (more control with a Base Year)
- NNN’s will almost always go up in areas that are growing in popularity or are being revitalized because the assessed values of all of those properties are going up.
- When a Landlord or leasing agent quotes you NNNs for a brand new building that number is almost always low because the building has yet to be fully assessed.
- Often, even in a building that has been around for a long time, leasing agents and Landlords will intentionally underestimate their building’s NNN expenses.
If your lease structure is NNN talk to a real estate expert about how to minimize your exposure to operating expenses and make sure your attorney negotiating the lease pours over the expenses section in the lease. That language needs to be favorable for you otherwise you could be another victim of the dreaded NNN lease.