CR003 TYPES OF LEASES USED IN RETAIL REAL ESTATE AND SHOPPING CENTERS
There are three basic types of leases used in retail real estate and shopping centers. Since you make an investment in real estate with the expectation of getting more money; the lease types describe how the tenant pays rent and who pays the expenses (i.e. Landlord or Tenant).
The lease types are: Gross Lease, Net Lease and Percentage Rent Lease. The tricky thing about these names is that you can sometimes get a combination of the types in one lease which we will address below.
Gross Lease A Gross Lease is where the Tenant pays only rent and the Landlord is responsible for paying the Real Estate Taxes, Insurance (Property Insurance for the building and Liability Insurance for the common areas) and the maintenance for the Common Areas AND maintenance of the building. It is rare these days to find Gross Leases on Retail Real Estate or Shopping Centers. When you do, it can be a GREAT OPPORTUNITY to add value when the leases come up for renewal. Or a long term Gross Lease can be a landmine as expenses increase exponentially over time and your Net Operating Income decreases to where you cannot pay your Debt Service (mortgage). A Gross Lease is the standard lease that residential landlords often use when renting an apartment. Gross Leases are also found in Office properties and Industrial properties.
Below is an example of a Gross Lease Analysis for Mega Tenant occupying your 10,000 square foot building on the corner of Main Street and Main Avenue in Megalopolis USA. Paying $10.00 per square foot. The expenses increase at 2% per year (because EXPENSES ALWAYS INCREASE).
Percentage Rent Lease
Most Percentage Rent leases today have a very high Minimum Rent sometimes know as Guaranteed Rent or Base Rent (a term also used with Gross Leases).
With percentage rental, the space is leased at a flat rate against a percentage if the tenant’s gross volume of business. If this percentage exceeds the Minimum or Guaranteed Rent guaranteed rental, the percentage rent is paid on a monthly or annual basis depending on ho the lease is structured. The Minimum Rent remain will remain constant even if the tenant’s sales are so low that no percentage rent would be paid. In the past, stores that did a higher volume of business also had less Gross Margin (less profit on each dollar of sales) so would pay less in percentage rent and less rent as a percentage of sales. For example, supermarkets typically only make three (3¢) cents of profit for every dollar of sales. Stores with a higher markup will typically pay a higher percentage rent rate and a higher percentage of sales to occupancy costs. A jewelry store is a good example of higher profits on each item sold.
The Percentage Rent is calculated by dividing the Minimum Rent by the Percentage Rent rate which will give you the Breakpoint at which the tenant will begin to pay Percentage Rent. This is called a Natural Breakpoint. The formula is: Rent ÷ Percentage Rate = Breakpoint
Below is an example of a Percentage Rent lease analysis for Mega Tenant occupying your 10,000 square foot building paying a Minimum Rent $1.00 per square foot with a Percentage rate of 10% of sales over a Natural Break Point of $10,000. The expenses increase at 2% per year.
Usually you will find a combination percentage and triple net lease. This type of lease guarantees not only that tenants will meet tax, maintenance and insurance costs, but also that percentage factors will increase the landlord’s income as the sales volume grows or as the rate of inflation increases.
A Triple Net lease (or “NNN” lease) is a real estate lease agreement where the tenant or lessee is responsible for the ongoing expenses of the property, including Real Estate Taxes, Insurance, and Maintenance, in addition to paying the rent and utilities.
The three major ongoing expenses (other than utilities and mortgage payments) related to owning a property can be placed into one of three categories:
• Real Estate Taxes (Property Taxes)
There are three basic types of net leases, defined by how many of the expense items are paid by the tenant. These items include Real Estate Taxes, Maintenance of Common Area (for example parking lot, parking lot lighting,, landscaping among other items) and Insurance (Liability Insurance for the Common Areas and Property Insurance for the building (the tenant will also carry its own insurance for contents in its premises and liability long with workers compensation)
- Net: (or N or Single Net) The tenant pays base rent plus the Real Estate Taxes.
- Net Net: (or NN or Double Net) The tenant pays base rent plus the Real Estate Taxes and Insurance.
- Net Net Net: (or NNN or Triple Net) The tenant pays base rent plus the Real Estate Taxes, Insurance and Maintenance costs.
You can use the acronym TIM for the progression from Net (T-axes), Net Net (T-axes and I-nsurance) to Net Net Net (T-axes and I-nsurance and M-aintenance)
The words “net and “net-net-net” are often used interchangeably (if not precisely), because it is generally assumed that a net lease is a triple net lease. In fact, wise retail real estate developers and investor will always try to write a triple net lease to minimize expenses and expense inflation risks. This means the tenant will pay rent per square foot on the space, plus a monthly charge for its share of the property taxes, insurance and maintenance.
Below is an example of a Triple Net (NNN) analysis for Mega Tenant occupying your 10,000 square foot building on the corner of Main Street and Main Avenue in Megalopolis USA. Paying $10.00 per square foot. The expenses increase at 2% per year.
Below is an example of a Modified Gross Lease Analysis for Mega Tenant occupying your 10,000 square foot building on the corner of Main Street and Main Avenue in Megalopolis USA. Paying $10.00 per square foot. The expenses increase at 2% per year.
Concordia Realty Corporation has been successfully connecting sound economics with experience in real estate for more than 28 years. We are a premier private real estate investment and management firm that creates value for our Investors, Tenants and the Communities where our properties are located. Our wide range of experience across a spectrum of real estate investments has consistently delivered superior returns. This experience has built a unique set of skills that helps to add value to all of our real estate ventures. We deliver increased returns to our investors, higher sales for our retail tenants, better living for our multifamily tenants, safer neighborhoods and higher valuations for our properties.
While Concordia Realty has done many different types of real estate investment, our main focus and most experience has been Retail Real Estate Investment, specifically Shopping Centers and Single Tenant Net Lease retail investments.
We hope to provide more educational information about Retail Real Estate Investment because there seems to be a need for better information available to the average investor.