Gross, Modified Gross, and Net Commercial Leases: Allocating Expenses and Risks Between Landlords and Tenants

In a volatile commercial real estate market, tenants and landlords alike are concerned with controlling expenses and allocating risk when entering a long-term commercial lease. How operating and occupancy expenses (and, therefore, risk) are allocated between the parties is governed by the lease structure: whether a gross, modified gross, or net lease. Counsel should be aware of the differences between the lease structures so they can best advise their clients.

In a gross lease, the tenant pays a single monthly rent payment while the landlord typically assumes all operating expenses, taking the risk that they have calculated sufficient rent amounts to cover return on investment as well as required repairs to the building or common areas and other variable expenses. A net lease requires the tenant to pay or contribute to the operating expenses and assume more risk, which usually results in a lower rent payment to the landlord. A modified gross lease is a hybrid version of the two in which both parties assume responsibility for certain expenses that vary depending on what is negotiated. This structure offers more flexibility to the parties and limitations can be negotiated into this structure to counter unpredictable expenses.

In addition to understanding how expenses are allocated based on the lease structure, consideration should be given to what constitutes occupancy and operating expenses so that these, as well as the responsible party, are clearly defined in the lease.

Listen as our expert panel discusses unique terms and considerations for each lease structure as well as how expenses are allocated in each. The panel will describe the risks and benefits to landlords and tenants for each structure and advise on best practices for negotiation and drafting.

1. Overview of current commercial real estate market
2. Terminology
   • Occupancy vs. operating expenses
   • Gross, modified gross, net, net net, triple net, absolute net
3. Lease structures
   • Gross
     • Expense allocation
     • Drafting considerations
     • Landlord pros and cons
     • Tenant pros and cons
   • Net
     • Types of net leases: net, net net, triple net, and absolute net
     • Expense allocation
     • Drafting considerations
     • Landlord pros and cons
     • Tenant pros and cons
   • Modified gross
     • Expense allocation
     • Drafting considerations
     • Landlord pros and cons
     • Tenant pros and cons
     • Major issues: roof, HVAC, compliance with laws
   • Other structures
     • Base year
     • Expense stop
4. Selecting the right lease structure for your client in a volatile market
5. Best practices for negotiation and drafting

The panel will review these and other key issues:

• What is the difference between occupancy and operating expenses and how are they typically allocated in each lease structure?
• What are the terms and considerations unique to each lease structure of which counsel and clients should be aware?
• How can landlords and/or tenants best mitigate their risk under each lease structure?
• Which lease structure is preferable to tenants and/or landlords in the current volatile commercial real estate market?