Modified Gross Lease in Commercial Real Estate: Getting the Right Lease Type
The type of commercial real estate lease you agree to can significantly impact your operation and bottom line. There are three basic types of commercial leases to choose from: gross lease, modified gross lease and net lease.
While each type of lease has its own advantages and challenges, many companies choose a modified gross lease for its ability to align with both the tenant and property owner’s priorities.
Continue reading to learn about the three unique types of commercial leases and why it’s important to know about a modified gross lease no matter your preferences.
Covered in this article:
- What is a Modified Gross Lease?
- Using a Modified Gross Lease
- Other Lease Types
- Pros and Cons of a Modified Gross Lease
- How to Negotiate a Modified Gross Lease
- Is a Modified Gross Lease Right for You?
What is a Modified Gross Lease?
A modified gross lease is a commercial real estate term where the tenant helps pay for a portion of the property costs in addition to their base rent. Also called a “modified net lease,” a modified gross lease is a happy medium between gross and net leases, which will be covered in depth below.
With a modified gross lease, rent is paid in a lump sum. However, prior to signing the lease, the property owner and tenant will negotiate which operating costs the tenant will cover. This lease type can be the most advantageous to both parties, as each can agree on terms that make the most sense.
Using a Modified Gross Lease
Modified gross leases are most commonly used in office leasing, as there are typically multiple tenants sharing one property. This allows multiple tenants to pay various portions for operating expenses (per their own usage) while maintaining a reasonable base rent. Additionally, the property owner is relieved of sole responsibility for property costs, thus saving tenant and owner from being locked into an over or underpriced agreement.
For example, one tenant in a back office of a commercial building may opt to pay only for base utilities such as electricity and HVAC, while another tenant in a front-facing unit may pay for common area and lobby maintenance to ensure curb appeal. Depending on the business, tenants should look to find a commercial space that suits their operational needs.
Other Lease Types
To understand a modified gross lease, it’s helpful to learn the other two primary types of commercial lease agreements: net lease and gross lease.
The primary differentiators between net and gross leases depend on varying price ranges for rent vs maintenance costs. Think of a net lease on one end of the spectrum and a gross lease on the other, with a modified gross lease ranging somewhere in between.
With a net lease, the tenant pays a lower base rent but must cover some or all of the property’s operating costs. These costs include maintenance, property taxes, insurance and common area maintenance (CAM). Common area maintenance can consist of services commonly shared by tenants throughout the building: janitorial services, sewer fees, trash collection, parking lots, landscaping and more.
Net leases come in several variations, with rent amounts adjusted based on what’s covered in terms of CAMs, building expenses, structural repairs and other fees. Net leases are typically more advantageous for the landlord because their tenants pay large portions of ongoing property maintenance.
With a gross lease, the tenant pays a higher base rent but doesn’t have to cover as many operating costs. Rent is often one large sum every month, and the landlord uses some of those funds to cover property expenses when necessary. Expenses include property taxes and insurance, utilities, janitorial services, building maintenance and more. However, individual property taxes and business insurance are still the responsibility of the tenant. A major advantage of a gross lease for the tenant is being able to accurately calculate expenses associated with the property, as many are already covered in the rent. Make sure you get the details on exactly what’s covered, such as the frequency of janitorial services and other ongoing maintenance.
Pros and Cons of a Modified Gross Lease
There are several pros and cons to every type of lease. When in the market for a commercial space with a modified gross lease, there are some factors to consider.
Advantages of a modified gross lease include:
- Opportunity for negotiation. Tenants and landlords both favor this process, and it’s especially effective for anyone with strong negotiation skills. If both parties come to an ideal agreement, they can enjoy a fulfilling long-term arrangement.
- Consistent rent amounts for tenants. Tenants benefit from this type of lease because rent amounts often remain stable and there’s less likelyhoold for unexpected rent increases. Fluctuations in operational costs can also be fulfilled by other new property tenants as the property owner negotiates them in. This benfits the tenants as it allows businesses to optimize efficiency and budget accurately.
- On-time payments for property owners. Because property owners have multiple sources of cash flow, they can easily manage expenses, pay taxes on time and achieve large financial goals. Compared to other types of commercial property leases, there’s more financial security for both parties.
- Rental agreement transparency. In most states, tenants have the right to audit the expenses of their modified gross lease. This holds the property owner responsible and accountable, ensuring all tenants of a commercial property avoid falling victim to over-collection.
- Simple lease structure. A modified gross lease is a flexible, reasonable lease structure. Once the negotiation is set, it’s relatively straightforward to maintain.
Challenges of a modified gross lease may include:
- Landlords must carefully select reliable tenants. Landlords face a big risk with a modified gross lease for commercial properties. If they’re new to property ownership and face irresponsible tenants, they might have to fulfill large financial obligations that were failed by the tenant.
- Businesses can experience conflict. With multiple commercial spaces for rent within the same property, businesses sometimes have little to no say over neighboring tenants’ activities. This can result in conflict and sometimes even litigation.
- Costs can fluctuate after several years. Some modified gross lease agreements have terms that specify consistent payments for the first two or three years. After this period, the lease could be open to renegotiations, depending on market conditions and local regulations.
- Property owners obtain landlord responsibilities. Property owners who offer modified gross leases often also take on the responsibility of managing the property. It takes time, resources and communication to manage a commercial property with various tenants. Tenants should be selective of the landlord they chose as the landlord will be the required party to handle conflicts, maintenance, and administrative duties of the property.
How to Negotiate a Modified Gross Lease
Commercial leases often involve negotiations. To get the best deal for your business rental, you must go into a negotiation prepared. Here are some ways to negotiate a modified gross lease.
1. Calculate Your Needs
Know how much space you need, including conference rooms, reception space, storage and individual office space. Calculate your office space needs by usable areas and rentable areas so you can compare them with modified gross lease terms. This information will inform your search, as well as your negotiation discussions.
2. Investigate the Commercial Landlord
Many people assume that commercial property owners lead the negotiation progress. However, this isn’t always the case. A volatile market puts tenants should search fora favorable position to negotiate. Its also important to get to know the landlord’s reputation, history and Net Promoter Score. Get ahead on a potential right-standing relationship.
3. Research Market Standards
If you don’t know current market standards, you risk being unaware of your options. Learn about the average price per square foot in a commercial rental space. Look up the average cost of property expenses. Talk to a local leasing expert to help you understand what your top priorities are for a commercial space. Then, use these facts to your advantage to find a suitable agreement.
4. Review Every Clause in the Lease Offer
All leases vary, which is why it’s crucial that you understand the terms and clauses in a lease agreement. Before you sign, make sure to consult legal counsel to cover anything that’s unclear or questionable. Then, assemble your counter-terms. You don’t want to get trapped into an unsatisfactory agreement.
5. Negotiate Through Your Counter-Terms
When you know your priorities, negotiables and non-negotiables, you can effectively negotiate with the property owner. The goal of negotiating a modified gross lease is to reach an agreement that benefits both parties.
Watch: Commercial Leasing FAQs
Is a Modified Gross Lease Right for You?
A modified gross lease can be one of the most flexible, cost-effective lease types for your business. If you prefer a commercial agreement that’s negotiable, predictable and ideal for office operation, it may be the best option for you.
To learn more about a modified gross lease and see if it’s beneficial to you, contact Hartman’s leasing team today.
About the author:
Sarah Hoopes is the Marketing Coordinator at Hartman Income REIT. She is a graduate of Utah Valley University with a Bachelor’s degree in Marketing and Business Management.