One of the more confusing areas for businesses leasing office space is the lease itself. Few things are as hard to compare as what tenants pay for their space, given the differences in how rents are structured.
There’s nothing wrong with the fact that there are different structures for office rents as long as the tenant fully understands what expenses are covered in amount of rent being paid. All too often, the unwary tenant later discovers there are myriad “hidden” costs that he or she was not aware of at the time the lease was negotiated.
Two things to keep in mind: (1) The tenant is going to pay all applicable costs one way or the other, no matter what the lease arrangement is; and (2) The tenant needs to know what those costs are and how they are to be paid well before the negotiations on dollar amounts begin.
So, what are these different costs and how are they covered under the different lease structures?
Office space leases are generally structured under one of the following three arrangements: “full-service gross,” “net of utilities” or “triple net.”
The “full-service gross” lease that is prevalent in downtown and center city area high-rise office structures covers everything. Included are the base rent, the tenant’s prorated share of real estate taxes, casualty insurance, common-area maintenance, property management fees, janitorial services, maintenance of the building’s elevators and heating, ventilation, and air conditioning systems, electricity, gas and water.
A full-service “net of utilities” lease includes all those items except the utilities, which the tenant pays separately. One cautionary note: Utilities sometimes are defined differently. In some situations, utilities cover electricity, gas, water and sewer. In others, it covers only electricity. The difference alone in what is covered under utilities can make a 2- to 3-cent difference in what a tenant pays per square foot each month. In a typical 10,000-square-foot office lease, that translates to a $15,000 swing over a five-year leasehold. Tenants need to be sure of what is being defined as “utilities” when they are “net of” — that is, not included in the rent itself.
Triple net, or NNN, leases cover only the base rent — the portion that represents the landlord’s return on investment. All the prorated expenses and the full boat of operating expenses are separate and in addition to the NNN rental figure. This arrangement is more prevalent in R&D and industrial spaces or in two-story, tilt-up office buildings in suburban submarkets.
The type of rent structure is not usually a negotiable item with landlords; it is what it is. What tenants need to keep in mind is that buildings that operate under NNN leases are not always cheaper to lease than those that have full-service rent structures.
For example, my associate, David Marino, offers a comparison of a full-service gross lease at $1.80 per square foot in a downtown high-rise office building with a NNN lease at $1.40 per square foot in a two-story R&D structure.
The $1.80 full-service lease includes everything. Marino points out that in a large high-rise building, those prorated costs that are included are amortized over a large number of tenants, thereby achieving some economies of scale.
Now, come with us to the suburbs to Marino’s analysis of the smaller, two-story, concrete, tilt-up office building. The $1.40 per square foot is only the base rent — the starting point. This is a smaller building where the various prorated costs for taxes, insurance, common-area maintenance, property management, building equipment maintenance and other expenses are spread among fewer tenants which often result in higher costs for these items. In this analysis, Marino is using an average of 32 cents per square foot. Add a 15-cent-per-square-foot average for electricity, gas, water and sewer, and to that, a typical cost of 6 cents per foot for janitorial service and the “lower” NNN lease is now $1.93 per square foot. Marino’s analysis shows that what, at first, seemed a cheaper rent is, in fact, more expensive than the full-service lease.
The office leasing industry hasn’t won any gold stars for keeping rent structures simple and easy for tenants to understand and make comparisons. As if it weren’t hard enough to keep the traditional definitions straight, some brokers are even using different terms to define the same thing. One landlord broker recently quoted Marino a lease rate that was “net of all expenses” which is the same thing as NNN.
Leasing is a complex business, requiring due diligence and a full understanding of what costs are covered under a given rental rate. Just as “buyer beware” should guide consumers in general commerce, “tenant be aware” should apply in today’s office leasing market.
Jason Hughes is chairman, CEO, and owner of Hughes Marino, an award-winning commercial real estate company with offices across the nation. A pioneer in the field of tenant representation, Jason has exclusively represented tenants and buyers for more than 30 years. Contact Jason at 1-844-662-6635 or firstname.lastname@example.org to learn more.