Office Lease Types
This is an update to the original version of the office lease article first published back in mid 2022. At the time, the “back-to-the-office” movement had just begun to gain momentum, and since then the office market has most certainly evolved. While the average office vacancy rates nationwide have hovered around 20%, some markets have experienced increased demand for office space, thereby stabilizing rents and in some instances even seeing increases. In South Florida for example, vacancies have dropped evenly across all office class types with a revived demand by office space occupiers of all types.
Given the renewed momentum towards bringing staff back to the collaborative environment that can mostly only be found in an office setting, we caution office space end-users to take the time to review the terms of their leases before inking the dotted line. It is fundamental for an organization to understand its office lease structure for various reasons, including lease cost projections, landlord and tenant responsibilities, and even the timing and process of exercising renewal options. In this article, we explore the three lease structures found in office space lease contracts and provide a comparison of each.
Explanation of Office Lease Rates
When searching for office space and comparing lease rates, tenants often find themselves confused about the disparity between lease rates of two or more similar-class office buildings in the same area. How is it possible that Building A has a lease rate of $27.50 per SF while Building B next door is $42.00 per SF? Let’s begin by understanding the anatomy of what makes up the “Lease Rate” Per Square Foot (PSF). Every Lease Rate, regardless of lease type, will have two components: the “Base Rent” and the “Operating Expenses” (“OPEX” for Short).
The “Base Rent” is the dollar per square foot portion of the lease rate that represents profitability to the landlord and is the portion of the lease rate that tends to be negotiable. The “Operating Expenses” or “OPEX” is the dollar amount that represents the landlord’s cost to operate the office building and includes maintenance, property taxes, and insurance. These operating expenses pass-thru to the tenant; however, there are some negotiation strategies where the amount of pass-thru to the tenant can sometimes be limited.
All lease types will have the same underlying anatomy, and the following formula will always hold (Base Rent + Operating Expenses = Total Lease Rate). The fundamental difference between lease types is how the financial responsibilities of the tenant and landlord appear within the lease contract language. The importance of having a lease agreement negotiated by an experienced office tenant representative, and reviewed by a qualified attorney, cannot be overstated. With that said, there are three office lease structures that we will discuss:
- Full-Service / Gross Lease.
- Modified Gross Lease.
- Net Lease.
Full-Service / Gross Lease
A Full-Service Lease also referred to as a Gross Lease, will always appear to be more expensive per square foot because it inherently includes both Base Rent and Operating Expenses expressed together as one aggregate figure. This lease type exists in Co-Working spaces, Executive Suites, and in some rare instances, traditional office buildings. This lease agreement will also tend to include electricity, water, HVAC, janitorial, even telephone, internet, and other expenses that tenants would expect to pay in addition to rent. The lease will require a flat annual increase for example of between 3% to 7% depending on the office market area, with no other financial responsibilities required from the end user.
Modified Gross Lease
The Modified Gross Lease is a variation of the previously explained Full Service / Gross lease. The fundamental difference is the additional financial responsibility allocated to a tenant. In a Modified Gross lease, the overall lease rate will have an annual percentage increase of again for example between 3% and 7%; however, if the landlord’s operating expenses also increase, the additional costs will proportionally pass thru to the tenant as an added financial obligation. Another key difference is that some or all of the tenant’s utilities, including electricity, water, telephone, and internet, are not included in the lease and will need to be paid directly by the end user. These types of leases are usually referred to as Modified Gross, net of utilities, janitorial, and/or anything else that is not included.
Net Office Lease (Net Lease)
The Net Lease structure is associated with well-located Class A Office Buildings, providing tenant amenities. The net lease structure is quoted by clearly defining the Base Rent and the Operating Expenses as two separate dollar figures per square foot. In this structure, the end-user will almost always pay for their utilities, amongst other tenant-related expenses.
There are four net-lease categories:
The “Single Net Lease (N)” requires the tenant to pay for Base Rent plus their proportional share of Property Taxes. The landlord is financially responsible for the other property-related operating expenses.
The “Double Net Lease (NN)” will have the tenant paying the Base Rent plus their proportionate share of Property Taxes and Property Insurance. The landlord will be financially responsible for the property maintenance costs.
The “Triple Net Lease (NNN)” asks the tenant to pay for Base Rent plus their proportionate share of Property Taxes plus Property Insurance and Property Maintenance, otherwise known as CAM. In this lease structure, it is common for the lease agreement to have carveouts as to what maintenance is the tenant’s responsibility and which shall be that of the landlord.
The “Absolute Net Lease” is sometimes confused with the Triple Net Lease but not the same. The Absolute Net Lease structure is more conducive to high credit tenants occupying single-tenant office property, for example, those tenants in industries such as life sciences, medical, or data centers. An Absolute Net Lease requires the end-user to pay Base Rent plus all property expenses, including taxes, insurance, and maintenance, and relieving the landlord from any upkeep responsibility.
Regardless of the title heading found on an office lease agreement, the details are in the language. As office brokers, our firm has encountered many instances where contractual lease language did not support the anticipated lease type. It is always beneficial to have an experienced office brokerage firm handle the lease negotiation and due diligence process, and have an attorney review every lease contract before executing.
Irving J. Diaz is a seasoned commercial real estate advisor and broker with over thirty (30) years of experience (Since 1993). He is a subject-matter expert involving a variety of commercial property asset classes and has represented a wide range of clients, including investors, developers, and corporate occupiers.