In the real estate investing community, residential property often gets the limelight. However, commercial properties—retail, office, and industrial real estate—can be less risky and more profitable for investors.
Commercial landlords also have more options when it comes to lease types and structures. Just as there’s no one way to run a business, there’s no established way to write a lease for business property either.
Landlords have considerable flexibility in the lease-writing process because of the wide variation of commercial real estate (CRE). You can choose how much responsibility to delegate to your tenants, depending on how involved you want to be and how confident you are in your tenants’ business endeavors or creditworthiness. Specialized businesses need even more flexibility.
Before investing in CRE, it’s critical to understand the various lease types so that you can best accommodate your tenants’ needs.
Here are three common structures for commercial leases and when each is appropriate.
Net Leases
Net leases are a common commercial lease type wherein the tenant is financially responsible for maintaining the property. This could mean making repairs and improvements or paying for utilities like water and gas.
Because tenants are responsible for all utilities in net leases, rent prices are usually lower to compensate.
There are four types of net leases: single net, double net, triple net, and absolute net or bonded. Each type adds another layer of costs that tenants are responsible for paying.
Single net leases require tenants to cover a share of the property tax in addition to rent and utilities.
Double net leases are like single net leases, but tenants also pay for insurance.
Triple net leases add on common area maintenance expenses.
Absolute net or bonded leases leave tenants responsible for all property costs. Tenants must pay for routine maintenance, repairs, and construction.
When to Use Net Leases
Net leases are a good choice for trustworthy tenants with strong credit histories. If you choose higher-level net leases (triple or absolute net), you should be fairly confident in your tenants’ abilities to finance and manage the property. You’ll have fewer responsibilities, but your freedom comes at a risk.
Gross Leases
Gross leases make you responsible for managing maintenance. Your tenant pays you a lump sum at the beginning of the term to be used toward maintenance.
There are two types of gross leases:
Full-service gross leases are the basic gross lease type. Tenants pay an up-front sum that you’ll use for building expenses throughout the term.
Modified gross leases still require tenants to pay a sum up front, but it only covers certain expenses. This type of lease is often used for businesses with specialized needs for amenities or utilities not typically included. Modified gross leases are fluid, meaning the tenant and landlord can negotiate their precise terms.
When to Use Gross Leases
Full-service gross leases are best used for single-tenant buildings, or multi-unit buildings with tenants who have similar needs. If you have a variety of tenants with different needs, a modified gross lease will suit them better as the terms can be adjusted to accommodate different business requirements.
Since gross leases require a payment up front, you are guaranteed those funds to use for maintenance. This factor also makes gross leases appropriate for tenants with less strong credit.
Percentage Leases
Percentage leases are most common for retail properties. With this type of lease, tenants are charged a base monthly rent amount plus a percentage of the business’s revenue.
Both tenants and landlords benefit from percentage leases. The more the tenant’s business prospers, the more rental income you collect. This makes you highly motivated to keep the property in good condition.
A new business often doesn’t profit for several years. You can accommodate start-ups by designating a sales limit, or breakpoint, before which you don’t charge the additional percentage.
When to Use Percentage Leases
Percentage leases are an excellent choice for tenants whose businesses are already well established, or which you are confident will profit highly.
Managing Commercial Properties
One similarity between residential and commercial properties is that both can be managed on property management software. Many software tools offer the ability to create and customize leases on the platform. You can build the infrastructure to match the exact type of lease you need. Then, you can make your lease structure a template to use with future tenants.
Tackling Commercial Real Estate
Commercial properties may be more profitable than residential ones, but they are also substantially more complex. Between the three lease types and the individual variation in businesses, managing commercial properties require a flexible mindset and a foundation of real estate knowledge.
However, the leases outlined here provide enough flexibility to suit any tenant. With the help of a software tool, you can manage your commercial properties efficiently and proficiently.
