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        Analysis of Commercial Gross Leases and
                                    Net Leases

Which Form of Lease to Use

Generally gross leases are preferred by tenants because the
tenant has certainty as to what their leasing costs will be
because all operational expenses are absorbed by the owner of
the project.  But net leases are preferred by the owners of the
project because operational expenses are passed onto the
tenants therefore there is no risk to the owner for operational
expenses.  Whether a gross lease or some variation of a net
lease are used in a particular rental arrangement is dependant
upon many factors and considerations.  

The first factor that may dictate whether a gross lease or a net
lease is utilized will be the relative negotiating strength of the
project owner and the proposed tenant.  If there are multiple
tenants interested in a space then the owner may be able to
require that a net lease will be utilized.  However if the owner is
anxious to have a particular tenant, such as a recognized tenant
who will generate increases in traffic for the development or an
anchor tenant who will lease a large portion of the project, or if
there is limited interest from potential tenants for a particular
space then the tenant may dictate to the owner that a gross
lease will be utilized.

Certain owners of commercial real estate projects will only utilize
net leases by choice.  Net leases are popular with commercial
real estate investors who acquire projects as investments as
opposed to acquirers who own developments with the intention
of managing those projects.  Because investors are not real
estate managers they often look to such acquisitions to generate
a set return on their investment without the potential for
additional costs being incurred which is best accomplished with
net leases.

And certain owners of commercial real estate projects are only
allowed to utilize net leases.  The owner of a commercial real
estate project may only be permitted to utilize a net lease if a
lender retains a mortgage on the project.  Lenders will often
require their borrowers utilize net leases so that the lender has a
degree of certainty as to what they are taking if they are forced
to foreclose on the project.  If a development does not utilize a
net lease and the lender is forced to foreclose on a project,
upon taking title to the property the lender may discover that
there are extensive maintenance costs and expenses that the
previous owner was liable for, which have not been paid and now
the foreclosing lender must pay those expenses or risk liens
attaching to the property.  Foreclosing lenders are also able to
ascertain with some degree of certainty what the operational
costs to them will be if they have to foreclose on a project if the
tenants within the project are subject to net leases which is often
a factor in the lender’s evaluation of a borrower, a potential loan,
and the collateral that will secure such loan.

The term of the potential lease may also affect the type of lease
that is utilized.  If the owner of the project and the tenant wish to
enter into a long term lease or a ground lease, such leases are
usually net leases because there is too much risk for the owner
being exposed to unexpected increases in the operational costs
for the development if a gross lease is utilized and if the owner
tries to compensate for such risk then the periodic rental amount
that the owner demands may be too high to be accepted by the
tenant.  Whereas if the lease is for a short term, such as a
period of time less than a year, it may be easiest for the owner to
enter into a gross lease to simplify the accounting for the project
while not exposing the owner to excessive risk of increases in the
project costs and the tenant would receive the benefit of
certainty as to rental expenses.

                            Return to Analysis of Commercial Gross and Net Leases
Law Office of
Craig W. Little, P.A.