Gross Lease vs Net Lease

When you look at commercial real estate rental agreements you will come across two common types of commercial leases. These are gross vs net lease. This article compares these commercial leases – Gross vs net leases and gross rent vs net rent when leasing commercial premises.

It is important

What is a net lease?

Under net lease structures, the tenant pays a base or net rent. On top of this, they are then charged an additional amount for outgoings. It is essentially an agreed-upon dollar amount when a tenant takes possession at the beginning of the period. In addition to this base rent, the tenant is responsible for paying the outgoings. This includes maintenance and repairs, management fees, real estate taxes, and insurance costs for commercial property, whether it is a commercial office, an industrial complex, or a retail facility.

This percentage is usually a percentage of the tenant’s gross lettable area related to the total lettable space in the building or centre.

The additional payments are a predetermined proportion of all maintenance and operating expenses, the property’s state taxes, management fees, and insurance costs. Although these may be excluded in certain circumstances, tenants must pay primarily compulsory charges. For example, if the tenant occupies 10% of the total lettable building area unless specified differently, the tenant will pay 10% of the total outgoings.

Many net leases may exclude items such as land tax and building insurance. That would mean that the landlord is responsible for paying those outgoings. The term triple net leases is often used to describe a net lease where all outgoings are paid by the tenant. Triple-net leases are usually more common with larger tenants. An example could be a national tenant, such as a supermarket or department store.

How do you calculate net rent?

Let us give the example of John looking at leasing an office building space of 100 m2 with a quoted rental of $300 per square metre under a triple net leases agreement The commercial property leasing agent also quoted the total outgoings for the building as $100,000 per year. Because the total lettable area for the building was 1,000 metres, John, the prospective lessee, was looking to lease 10% of the lettable area.

We can work out what John’s net effective rent would be from the above.

Area 100 square metres x $300 (price per square metre) = $30,000 pa (net rent)

Also, John would have to pay outgoings, including land tax percentages and management fees. (as per usual, triple net leases)  Below is the calculation.

Outgoings/property expenses quoted for whole building: $100,000 x 10% (percentage leased)

Outgoings payable is therefore $100,000 x 10% = $10,000 per year

This would mean that if the final outgoings were the same as quoted, John would be liable to pay a total of $40,000 per year.

Calculated as $30,000 (rent) + $10,000 (outgoings) = $40,000

To put in a nutshell, the rent amount is broken up into two parts:

(1) The base rental, which usually increases annually at a fixed rate (CPI or market value) and

(2) A proportion of the outgoings increases at the same rate as the actual outgoings for the individual property.

What are the advantages of a net contract agreement?

These types of net leases are usually favoured by property owners and new real estate investors. They give more security of investment return if the percentage of outgoings increases faster than base rent. The tenant will have to absorb this increase in this real estate investment.

What is a gross lease? 

In summary, gross rent is the opposite of net rent. Under a gross lease, the tenant pays a whole gross rent amount that includes all common area maintenance in most cases. Other additional expenses include property taxes, insurance costs, maintenance costs, and council rates for the entire term of the lease. The tenant has no obligation to pay rent other than the basic gross rental. The landlord usually calculates this and has the outgoings included in the total amount based upon the anticipated expenses. Sometimes, a tenant may pay a percentage of the increase in outgoings from the lease’s first (base) year. On other occasions, depending on economic factors, the landlord may choose to absorb some of the outgoings under a modified gross lease. This is usually more popular with tenants because it can avoid cost surprises.

What are the advantages of a gross contract agreement?

The main advantage is that it puts an upper limit on the maximum rent payable to the landlord. On the other hand, the landlord may choose this method to attract tenants in testing economic conditions.

The landlord will have to absorb an accelerated increase in outgoings in this situation.

Gross Rent Calculator

The following example is from another office John was looking for in the same area. In this example, the landlord was looking at offering a gross lease agreement.

The office size was of the same size (100m2) and similar position and quality. The quoted rent was $41,000 per annum.

This gross rental was going to be more expensive for the first year than the $40,000 John was quoted in the net lease example.

Should the tenant take the gross or net rent agreement?

It looks like it is better to go for the cheaper net lease agreement on the surface. Whether it is better depends on whether the tenant thinks that outgoings will increase faster than the annual rent increases.

If the annual rent increase was 3%, and the outgoings grew to 6% per year, then the gross rental agreement would look better in the long term. On the other hand, it could be a better choice to go for a gross lease if you thought that outgoings would increase 1-2% per year, with everything else being equal, including rent increases.

 What is the average rent increase per year of a commercial lease?

Commercial real estate lease increases can fluctuate, usually in line with the current inflation and interest rates. For example, in the late 1980s, it was common to see fixed rate increases by 10% or more. We see lower average increases with the consumer price index at record lows. The question is; What is the average rent increase per year at the moment?

Most lease agreements have annual commercial rent increase percentage increases. This varies depending on the type of commercial property and the current economic conditions.

The theory is that annual increases ensure that the return to the landlord reflects the increases in property value and operating costs. Whether this is a true reflection of the actual market rent is a topic for future discussion.

What are the more common commercial property rent increases?

From the hundreds of leases that I have seen over the last few years, I estimate that around 90% have increases of the consumer price index (CPI) or 3% per year from the base rent. The others are more common with the large shopping centre leases which state rent reviews of 4 to 5% or CPI plus 1 or 2%. As a result of recent inflation increases this CPI (consumer price index) percentage has increased with new leases.

These percentages of growth can vary in the options to renew the lease. For example with the recent growth of inflation figures I would not be surprised that landlords would be pushing for more CPI type increased and raising the more popular 3% increases to a higher one.

Some might argue whether the cumulative increases in rent over the long term lease could be more substantial than the individual revenue growth and profit.

In some states of Australia, the rent movement clause in terms of the lease for retail leases limits increases to CPI or a fixed percentage – not the greater of which has been allowed with many other commercial leases.

Commercial rent increases are a crucial clause in the lease. It would be good to get to know the current market rentals for your business area from an experienced commercial real estate agent. Also, ensure that you discuss this with your specialist commercial leasing lawyer.

This is even more important when taking over an existing lease (assign the lease). Trying to work out annual rent reviews in some of the more recent lease (law society) contracts I have seen many times used by most solicitors is akin to playing snakes and ladders.

What is the difference between net & gross rent?

What is Gross Lettable Area in a commercial lease?

Gross Lettable Area (GLA) is a term of great significance in commercial real estate. GLA is different to the net lettable area.
It refers to the total floor area within a commercial property available for leasing to tenants. This includes all spaces that can generate rental income or be rented out. Beyond just the tenant-occupied areas, GLA, distinct from net rentable areas, includes floor space, corridors, lobbies, stairwells, elevator shafts and other shared spaces.

Breaking Down the Components

To get a better idea, let’s break down the components of Gross Lettable Area. Picture a crowded shopping centre with stores, storage rooms, hallways, a food court, and a central gathering area. All these spaces contribute to the gross leasable area GLA. Each segment plays a crucial role in the bigger picture.

Significance of Gross Lettable Area

Gross lettable area is significant for various players in the commercial real estate arena. Building owners and managers use GLA to determine lease rates and rental values. Prospective investors interested in purchasing commercial properties analyze the GLA to evaluate the potential return on investment. Furthermore, businesses seeking to lease a space utilize this metric to comprehend the overall area available for their operations.

Examples of Gross Lettable Area :

1. Office Space:
Consider a modern commercial office building. The GLA encompasses office suites and shared amenities such as meeting rooms, hallways, restrooms, and common lounges. Building owners and managers consider the entire GLA when calculating lease costs, ensuring fairness in valuing each square metre/foot of leasable space. For instance, if a company desires a 200-square-metre office within the building, they’re paying for their dedicated area within the GLA and a portion of the shared spaces.

2. Retail Outlet:
When looking for leases in a shopping centre, GLA accounts for all individual tenant space/retail shops and communal areas like food courts, walkways, and relaxation zones. Retailers within the mall don’t just rent their individual shops; they benefit from the foot traffic generated by these shared spaces. This underscores the pivotal role of GLA in determining the attractiveness of retail space for businesses aiming to establish a presence.

In Conclusion: The Full Scope of gross lettable areas

In commercial real estate, Gross Lettable Area considers every inch of space that can be leased, guaranteeing that property owners, investors, and tenants possess a holistic view of the income-generating potential. GLA is a guiding metric for determining lease rates, investment viability, and overall business success from offices to shopping malls.
This should not be confused with a net leasable area. This is the actual exclusive area within the parameter of the premises. The area inside a tenant’s building wall and does not include the common areas.

When looking at commercial space, remember that behind the scenes, it’s not solely the visible areas that matter – the entire Gross Lettable Area moulds the commercial real estate landscape.
This should be taken into consideration when looking at investing in commercial property.

multi storey retail commercial building with gross and net leases palm trees on front

What is a net lettable area in a commercial lease?

Understanding the Net Lettable Area (NLA) when negotiating commercial real estate leases is critical. The net lettable area is the exclusive space leased to the individual tenancy. You must understand and consider several other items in the commercial building lease negotiations.

How do you calculate Net Lettable Area (NLA)?

It is crucial that this is done accurately. First, you must measure up all the lettable areas of the particular property’s floors. It involves measuring all the internal spaces within the walls and the prevalent portions of the permanent outer building walls.

What items are included in calculating the net lettable area?

When calculating net lettable areas, particular items are usually included. This total area includes permanent or structural columns and window frames. Fire system items attached to the walls, such as hose reels, fire blankets, and any additional internal finished surfaces created for the individual tenant.

When a tenancy area is subdivided, the centre line of the dividable wall is generally used as a parameter for the NLA. The exception is when the leased area adjoins the external walls of the common building area.

What items are usually excluded in calculating net lettable area?

A number of items or areas are usually excluded when calculating the net lettable areas for the rental amount.

These are usually shared spaces like hallways, stairs, elevators, utility closets, restrooms, mechanical rooms, lobbies, and recreational areas. All the tenants can use these areas. As a result, people typically do not include them when calculating the net lettable areas.

How are External areas treated with net lettable areas?

The count usually does not include verandahs, balconies, terraces, and covered areas. However, depending on the specific areas, they may be considered during lease negotiations.

What are other considerations when negotiating net-lettable areas?

Seating and extra display areas in common areas in shopping centres. Additional seating areas include cafes and dining areas or extra display/sales areas. They are usually negotiated separately from the commercial property lease.

A separate application is required when seating is requested in a public area, e.g., footpaths or laneways owned by councils. With these agreements, the authority would grant the use of a certain maximum amount of seating. It may include other conditions, as these approvals are usually only valid to the original applicant. As such, a new tenant must reapply for this approval when the existing tenant’s lease is transferred. For example, on the sale of the business or transfer of the lease

How local councils can affect property usage

Local councils have been known to change policies, and landlords and tenants should also be aware of this. 

A good example of this was a situation with a recent cafe sale negotiated directly between the cafe owner and a buyer without a business broker. Most of the seating was on council-owned property with old approval.

The buyer was in for a big surprise when they reapplied for seating while taking over the business. They didn’t know that the council had changed its policy, which reduced seating and revenue. You can say that this was a costly lesson.

Another more common item with rental amounts on leases is parking. It depends on the premises. Parking can be included in the lease or leased under a separate licence agreement in a larger shared parking area.

Business leasing can be complicated, especially when buying or transferring existing leases. We suggest working with an experienced lawyer, commercial real estate agent, or coach who knows about commercial property transactions.

Which is better – gross or net leases?

As a landlord, it depends on your own and general economic conditions and what is required to attract your ideal tenant. Generally, most landlords feel more secure with net lease agreements in better economic conditions. That way, future rental amounts are more predictable. In addition, the tenant bears the risk of unforeseeable extra maintenance expenses.

Would you like to discuss further? Contact Con Tastzidis at CST Properties Commercial Real Estate Agents and Business Brokers on 9882 2221

Con Tastzidis - Sydney Commercial Real Estate Agent & Business broker

Written by Con Tastzidis
Con is Managing Director of multi award-winning Commercial Real Estate brokerage and consulting company CST Properties since 2001.
With over 40 years of hands-on experience, Con Tastzidis has etched an indelible mark in the Hotel, Tourism and leisure commercial property and business sectors. Having engaged with national and international hotel and property companies/owners, Con possesses a profound understanding of the intricate dynamics that drive success in this arena.

Con is the author of several books, including Amazon top-selling book “Real Estate Investing For The Residential Investor-The- The 7 Myths of Commercial Real Estate Explained”. In this book, Con outlines many of the successful outcomes he has achieved in both good and adverse economic conditions for his clients. More importantly, how working with Con can work for you. Con has been featured in several national and international media outlets, including FOX, CBS, NBC, ABC, CNN, and BLOOMBERG.
If you would want to work with Con, he can be contacted through this link Feel free to contact Con Tastzidis at CST Properties.