Commercial Real Estate Leases Explained (NNN, Gross, and Modified Gross)
Two identical commercial spaces. Same size, same property type, but one is worth $97,222 more because of how the lease is structured. One rents for $14/SF triple net, while the other brings in $18/SF gross. You'd think the higher rent means a better investment, right?
Not necessarily.
Today, we're breaking down how lease structure impacts your net operating income, cap rate, and ultimately your property's value.
We'll also cover three lease terms that may actually be worth accepting lower rent to secure.
Because in commercial real estate, it's not just about how much rent you collect. It's about how much income you keep and how predictable that income is.
Key Takeaways
The lease terms—not the label—determine who pays what. Review the responsibilities for property taxes, building insurance, and common area maintenance (CAM).
Triple net (NNN): The tenant pays base rent plus its share of taxes, insurance, and CAM. The landlord typically remains responsible for major building elements; an absolute net lease may shift more responsibility to the tenant.
Gross and modified gross: In a full-service gross lease, the tenant pays one amount and the landlord covers most operating expenses. Modified gross leases divide expenses according to negotiated terms.
Expense increases can create risk. Under a gross lease, rising expenses can reduce the landlord’s net income. NNN leases pass certain expenses through to tenants.
The speaker’s preferred structure is modified gross with a base-year expense stop. The landlord covers expenses up to the base-year level; the tenant pays its share of increases above that.
Tenants should review CAM terms carefully. Consider caps on controllable expenses, exclusions for items such as capital replacements and leasing commissions, and an audit right to verify charges.
Read the detailed clauses and involve an attorney. Clarify who repairs versus replaces items such as the roof, HVAC, and parking lot, and review escalation, assignment, renewal, and permitted-use terms.
About Your Host:
Tyler Cauble, Founder & President of The Cauble Group, is a commercial real estate broker and investor based in East Nashville. He’s the best selling author of Open for Business: The Insider’s Guide to Leasing Commercial Real Estate and has focused his career on serving commercial real estate investors.
Tyler Cauble
This episode of the Commercial Real Estate Investor Podcast is brought to you by my CRE Accelerator Mastermind, where you'll get access to my step-by-step investment blueprint, essentially a library of resources on how to invest in commercial real estate. You'll get connected to a supportive community of other commercial real estate investors that are doing projects just like you. You'll get personalized coaching and feedback from me every step of the way. Go to www.crecentral.com to learn more. Welcome back to the Commercial Real Estate Investor Podcast. We are live from the Cobble Group Studios here in Nashville, Tennessee, for another round of office hours. We go live every Tuesday, 830 a.m. Central Standard Time, answering your questions about commercial real estate. And today, that has to do with the three primary different lease structures that you have in the commercial world. What's the difference between them? Why are there different types of leases? And I'm going to tell you guys the one lease structure that I'm actually using more than anything else, and it's not triple net. I know everybody would think it's triple net. When you look at commercial real estate, you want to get into it for the triple net leases. That's actually not always true. There's a better lease structure, in my opinion, than triple net, depending on the types of tenants that you are dealing with. This week is going to be a big week. I am going to be in Chattanooga tomorrow. We had a massive event last night for the Entrepreneur Center, which was a lot of fun. And starting Thursday, we've got the accelerator members here in town for our in-person mastermind on business systems and commercial real estate. So it's going to be a busy week. So with that being said, let's go ahead. Let's dive on in. Let's talk about commercial real estate leases. We're going to explain the triple net, the gross, the modified gross, and like I said, my go-to for all of this. By the way, if you guys are just now tuning in, I've got a quick favor to ask you. If you've been listening to the show, if you enjoy what we are doing here, the feedback is always appreciated. If you're listening on Spotify or Apple Podcasts. Please rate and review. That way, more people can help, or you know, can go out and find the show, and that'll help us get in front of them. So I appreciate that. All right, let's dive in. So really, the the biggest difference between commercial releases comes down to who pays the operating expenses. How is that all broken out? Most commercial leases are like 95% the same. Almost everything is going to be identical across all three of these different lease types. Four, technically, with the one that I'm going to show you guys here in a little bit. But it comes down to property taxes, building insurance, and common area maintenance. For those of you that are not familiar, common area maintenance or CAM-that's like the lawn, the lot, the lights, the snow, the shared plumbing. That is what your tenants are going to be reimbursing you for maintaining all of that. Because if you think about it, if you've got a roof. Roof repairs will probably fall under CAM instead of you know one tenant being responsible for maintaining the their pro rata share of the roof. It just there's things like that that just don't entirely make sense. Now, on a single family rental home, you pay for all of these, right? Even in multifamily and apartment complexes, you are responsible for paying for all of these. Now, that means that the tenant writes you a single check. They're probably paying their own utilities, but then out of that check, you're paying the property taxes, the insurance, the commonary maintenance out of that. And if there is a situation like what we've seen over the past couple years, where property taxes go up, for example, in Nashville they've gone up over 30% in the past couple years. If your insurance goes up, if you're in Florida, you're probably dealing with some pretty crazy insurance rates now. That means that that is going to directly hit your bottom line, and I'm going to show you guys more about that here in a minute as to how devastating that can actually be as a landlord.
Tyler Cauble
But on the commercial side, it completely depends on what the lease says. You can structure it in so many different ways. Two identical suites in the same building can split those costs very differently. You could have a lease that you inherit where you are responsible for everything. You could have a new lease that you sign that is triple net. You can structure it kind of however you want. All right. Now, every lease type has its pros and cons. There's different reasons as to why you would do different lease types, and we'll dive into that today As well, so let's see three different structures, same building, same square footage, but these are going to be three completely different deals. All right, so let's look at triple net first. The tenant is responsible for paying base rent plus their share of taxes, insurance, and common area maintenance. Now this. Doesn't like to be very clear. This is for the building, all right. So it's building insurance. This is not like their liability insurance. They will still need to go out and get their own liability insurance as well. Okay, triple net is very common in retail and industrial. You're starting to see it more and more often in office these days as well, which is kind of wild. Office traditionally has been full service gross or modified gross, but triple net is is making its way in. All right, gross. The landlord is responsible for just about everything. All right, so the tenant pays one number, the landlord pays everything out of that. Okay, so you know, tenant pays to the landlord. I want some landlord turns around and pays for janitorial, common area maintenance. You know, anything else that's going to actually come out of that check for running the property, landlord is responsible for everything. It's very common on office buildings. All right, then we have modified gross, and modified gross gets really interesting because there's essentially an infinite number of ways that you can actually set up a modified gross lease. So it's it's kind of tough to actually determine how these are always set up or what is market, because it's kind of up to you and the tenant as to what y'all want to lease or negotiate, rather. But both, I mean, you you're splitting however the two sides agree, right? With with the expenses, all right. There's no standard definition which which can trip investors up. I'm sure it could trip up you know businesses as well. But make sure that you are paying attention to this. One thing that I do want to point out, and it seems like it's it's common knowledge, but I know that you know oftentimes it's not. When you're looking at a lease, it's not going to explicitly say this is a triple net lease. It's not going to explicitly say this is a full service gross lease or a modified gross lease. Leases are not drafted like that. It all comes down to the operating expenses, the tenant's responsibilities, and the landlord's responsibilities. So, whenever you are going through and reviewing commercial leases, go check that first. That will tell you right off the bat whether this is triple net, this is full service, or this is modified. All right. So in a triple net lease, here's what the tenant actually pays: base rent, and that's often stated on a per square foot price per year, all right. So it could be $20 per square foot, all right. We do that because the tenant may want to take a little bit more space. They may want to demise the space, you know, in half. So there's a rate per square foot. Okay, property taxes that is based on their pro rata share. So if they occupy 50% of the building, they are responsible for 50% as their pro rata share. That's also the same on building insurance and common area maintenance. They are responsible for their pro rata share. All right. So again, you know, if they take up 10% of the property, they will be responsible for 10% of the property taxes, building insurance, and common area maintenance.
Tyler Cauble
Now, in a triple net lease, and I see people get this wrong all the time in a triple net lease, the landlord is still responsible for the roof structure, the actual building structure, the parking lot, utilities that you know basically up to the building. So keep in mind that just because it's triple net, the tenant's responsible for, you know, the property taxes, building insurance, and CAM does not necessarily mean you're completely off the hook as a landlord. I see people confuse an absolute net lease with a triple net lease all the time. All right, so an absolute net lease is a version of a triple net lease where the tenant is then responsible for the roof, the structure, the parking lot, etc. That is more common when you are doing a build to suit ground up development for a tenant, like a Starbucks. All right, now Starbucks doesn't necessarily sign an absolute net lease. I'm trying to think of like who's a good example of who might or who might have like Walgreens probably so, right? Where you're building a purpose built building for them. It is single tenant. There is no one else that's going to be responsible for anything, right? So they don't have to argue over whose part of the roof is actually leaking, and tenants will actually prefer to have structures like this sometimes, because that means that they are in complete control of their destiny. If you think about, you know, your your AutoZone or your Hardies or your Walgreens, right? You may not necessarily want to wait for a landlord to come in and. Fix the roof. You might have to deal with that pretty quickly because you have customers coming in and out, so that is why a tenant might structure it in like an absolute net lease. All right. So on the triple net side, like here's how each side kind of feels the landlord gets more predictability, right? The rent is actually like the base rent, especially is pretty close to their net income. You know, taxes go up, insurance might go up or down. The parking lot needs to be sealed. It all passes through to the tenants. Okay, the predictability is why lenders and buyers pay more for net leased buildings. That is a strategy that you could implement as a commercial real estate investor in this game. Go out there, buy a building that has a bunch of full service gross leases, turn them over to triple net leases, and then flip it on a on a much stronger cap rate. You actually get a lower cap rate by going through, and I mean, all things could be equal. You could actually have the exact same net operating income, but if the lease is full service gross compared to triple net, somebody's going to have to price in the risk of it being a full service gross. So you're actually going to get a higher cap rate, even if the NOI is the same. Something to keep in mind. Now the tenant has you know a little more uncertainty, right? There's a number that they can't really fully forecast. Now you could make the argument of like, okay, well if the county's going to reassess the property taxes, you probably know that within enough time. If the insurance market's going to move, you're probably going to know that within enough time. But those are things that are not necessarily set anymore. All right, so they they like it could adjust on a year to year basis. You know, good tenants are okay with that, but they will push for caps 5% a year, 10% a year. They will want to see caps on how much what are called the controllable expenses will go up every single year. Now, I as a landlord am fine to give them caps on the controllable expenses. Controllable are things that I can control. All right, that's generally your common area maintenance. What is uncontrollable are the property taxes and building insurance. I don't have any say in how that gets set up, but I can control how often we're doing janitorial. All right, so that's like that's why if you look at these commercial leases, it is typically broken out as controllable and uncontrollable expenses, I'm willing to put a cap on the controllable expenses-the things that are actually in my control. All right.
Tyler Cauble
So neither side's being unreasonable when they're negotiating. They're just trying to make sure that they are accounting for the risks that are going to be involved on their end. I mentioned this earlier, but look, the label is not in the lease, you know. Like triple net, it's not going to get called out. So, like here's some here's some more things for you to actually take a look at. I forgot this slide was in here. The roof, right? So does the lease say repair, or does it say repair and replacement? Just having and replacement in there, huge difference. All right, you guys were here last week when I was telling you about a buddy of mine who bought a building, or maybe it was a couple weeks ago. I can't remember. It was a totally normal lease, except for one sentence at the end of a paragraph on like page 27 or whatever said, "Oh, you know, tenant doesn't have to pay rent in November. Everything else was like totally fine, totally normal. You know, here's the monthly rent collected. Here's your monthly reimbursements. Whatever it is, that one sentence at the end of a paragraph, towards the end of the lease, completely changed the cash flow of that deal. When you're buying commercial real estate, these leases are incredibly important. They are the agreement by which you and the tenant are going to operate. So make sure that you understand what you're getting into and read everything, because one sentence at the end of one paragraph on page 27 can totally change how the deal is going to work. All right, the structure, foundation, load-bearing walls, exterior walls. If you've got a sloppy common area maintenance definition in your lease, it could sweep all of that into the tenant pool. Which, like, as a landlord, not necessarily a bad thing, right? Unethical landlords will do that all the time. They will try and pawn off all sorts of crazy things onto a tenant. That's just not market rate. That's why it's important for like one, just be a good person, be ethical, and two, make sure you've got an attorney involved. I I will be like, you know, to be fair to landlords, it doesn't hurt to ask for certain things if the tenant doesn't have an attorney or their team doesn't know what they're asking for. That's when things start to go wrong. I mean, that's why I wrote my first book, Open for Business, because I'd worked with so many small business owners that had gone through and signed these terrible leases that no business should have ever signed. It happens all the damn time, all the time. And then the parking lot, so ceiling and striping-that's maintenance. But if you're going to tear it out and completely repave it, that's a capital expenditure. So capital expenditures do not go into common area maintenance. That's not maintenance, right? So make sure that you understand which is which in writing with $1 threshold. Okay, and read the CAM definition, right? So, if if you're a landlord structuring a lease, you don't necessarily have to worry about that. If you're a landlord that's buying a property with a lease in place, all of this is going to matter. All of this is going to matter. And of course, if you're a tenant, it's definitely going to matter. All right, grosser full service. One number carries it all. All right. So the tenant writes one check every single month. Let's say it's $18 a square foot. Then out of that, the landlord's going to pay the taxes, insurance, and CAM. Let's just say that's $3.50 a foot. Let's look at so our taxes on the suite $5,000 a year. County reassesses goes up 15% So we've just added $750 a year in additional expenses. The landlord now has to pay for that. All right. If it's a modified gross or full service gross lease, like if your your taxes go up, you are now paying for that. If it goes up $750 on an 8% cap rate that is $9,400 of value on the property that you have just lost because your property taxes went up. Think about that. Let that sink in. Your property taxes went up $750, and you just lost $9,400 in value. That is why it is so important for landlords to have a triple net style lease structure.
Tyler Cauble
I say style because I'm going to tell you guys about my favorite lease up here in a minute, and it's not one that I've found a lot of people know about, or is or is very common. So when you convert all of that to a cost per foot, you know, looking at triple net versus gross, they can look drastically different and kind of come out to be the same, though, right? Like that's the interesting thing about it. So like if you're looking at the triple net here, it's $14 a square foot triple net. Your triple net expenses are $3.50 a foot, so that comes out to be $17.50 a foot. All right, so your all-in cost per year on the rent is 43,007 50. Now, if we look at a gross lease, let's just say, okay, what's $18 a foot gross? Okay, well, $14 triple net and 18 gross. Like 18 sounds a lot higher, right? That's why triple net can be nice sometimes when you're talking to tenants. It seems lower. They don't understand the difference. I mean, it's not an intentional deception. Like it just genuinely, when you're looking at it on a piece of paper, like it looks like it's less. The expenses that the tenants paying on top of that on that $18 gross is zero. So they're all in cost per square foot is 18 bucks, which means you're all in cost per year is $45,000 compared to the 43 750 on the triple net side. The reason that landlords like quoting in gross rates instead of triple net is that you get to tell them, hey, it's 45,000 a year. Now you just it is what it is, you know. You pay your own utilities, whatever, right? In triple net, you got to say, well, your base rent is this, and then you're going to pay your $3.50 a foot in common area maintenance, property taxes, and building insurance on top of that. It's based on your pro rata share, and they're going to go, well, why do I have to pay that? You know, it's it's like, well, that's a stupid question. It's because you're occupying the property, and I'm not charging you on a gross rate. I mean, like you will. It's so funny sometimes. These tenants will be like, "Well, I don't want to pay that. It's like, okay, well, if I quoted you $18 gross, you wouldn't have said anything, right? Like, it's it's either 1750 or like like 14 triple net or $18 gross. Like it just it is what it is. Those are the same two things. All right, they're just quoted differently. It's but it's funny. You know, you'll deal with some small businesses sometimes that have just never negotiated leases, so they don't understand how it works. Or even worse, you'll deal with a residential agent that has no idea what they are doing when it comes to commercial real estate, but somehow they are representing a business. I have dealt with this so many times over my career, and I always just feel so bad for these businesses that have a residential agent representing them, because that resi agent will try and negotiate the triple net expenses, like they were trying to negotiate. What the tenant pays for for the common area, man? It's property taxes and building insurance. I'm like, listen, you are you can pay whatever you want, but if you want to pay a different level of property taxes, you got to take it down to the county, and you got to deal with them and negotiate with them for this whole building to pay less in property taxes. I'm not just making these numbers up, it's pretty funny. Here's three things that will bite tenants when it comes to these commercial leases. So they will not negotiate a cap on the controllable common area maintenance expenses. Ask for 5% a year cumulative. You can ask for caps on these expenses, and a landlord that is reasonable should be willing to put a cap on that. Like you can't just have an unlimited growth rate on controllable cam. Now property insurance, you know, property taxes. I get that. Like yeah, you can't really control those. Okay, so you probably can't put a cap on that. The no exclusions list. You got to make sure if you're a tenant.
Tyler Cauble
I mean, obviously, I guess if you're a landlord, it may be a little bit different. But on the tenant side, like you want to make sure that the common area maintenance does not include capital replacements or leasing commissions or landlords' financing costs or marketing for the property. They should all be out of that pool. Now, landlords can't actually sneak this stuff in, and anything that you guys agree to in a commercial lease is what is the case. None of these should actually be in there, right? Capital replacements. Your tenants should not be responsible because you decide that you want to replace the roof. Like they shouldn't now have to pay for the roof because you've decided that they shouldn't pay leasing commissions for your broker because you decided to lease one of the other suites. So now the other five tenants in the building have to pay your commissions to put that tenant in there. There's also, like, I mean, again, you know, I've seen crazy things in these leases because these businesses didn't have attorneys negotiating their rights. Very, very important to make sure that you're getting attorneys involved at every single point of the process, no matter which side you're on, and of course, no audit right. I want my tenants to have an audit right. You know, if you if you don't believe my numbers when it comes to cam tax and insurance, you can audit it. Here is how all of that works. Here's what you can request. Here's how much time you have to do it, I'm fine with it. Like it's an it's open book. I don't care. It's cam tax and insurance is not a profit center for me or for you as a landlord. Those are expenses on the property, and you should be able to back all of them up. So I mean, part of this is just like how to be a good ethical landlord, right? But part of this is also just like good business practices. You want to make sure that you have everything put together. All right, here's the lease that I love the most. It is one of the easiest to explain to a tenant, but it also protects you in the exact same way that a triple net lease will. It is called a modified gross lease with a base year expense stop. All right, you'll see it called an expense stop, a base year stop. I just always call it a base year expense stop. That gives the tenant a number that they can budget. The landlord, you don't have to carry the inflation of your expenses, and nobody has to really worry about do they trust each other. All right. So the way that this works, year one, let's say it's $18 a foot modified gross. Tenant pays their utilities, but you have a year one base year expense stop. So let's just say it's you know $15 in base rent and $5 a foot in actual cam tax and insurance. All right, so that means that I am going to be covering the expenses out of that full service lease for the first year, but I can predict that because I already know what those expenses are going to be as the landlord, so I can set it to the rate that I need it to be. What a base year expense stop does is it keeps the landlord from paying past the stop, the quote unquote stop. That's the first year of expenses. So if our expenses go from $5 in the first year to $6 in the second year, I as the landlord is still paying the five, but the tenant is paying the additional dollar above and beyond that, just like they would in a triple net lease. So, the result is like the tenant has one known number with small increases every single year of what their expenses are going to be, and you, as the landlord, get effectively a triple net lease, without then having to sit there and explain the difference between base rent and additional rent, and what commonary maintenance is, and property taxes, and building insurance, and all this kind of stuff, they understand. Like, hey, yeah, typically after I take occupancy of a space, the expenses are probably going to go up, and I should be paying my my share, my pro rata share of those expenses.
Tyler Cauble
As they go up on this property, so it's it's the easiest type of lease to structure. It's called the modified gross with a base year expense stop. Take that one to your attorney. Use it on everything. I mean, it's just it's a it's a phenomenal lease structure. It's it'll make your life a lot easier. Here's how the stop could look like using some real numbers. All right, so let's say our operating expenses are running at $6 a square foot in year one, and they increase by 4% per year. So our base year expenses are $6 a foot on this 2500 square foot suite we're looking at. That is $15,000 per year. In year two, if our expenses go up to $6.50 a foot, so that's a 50 cents increase, that puts us at $16,250. So I, as the landlord, am still paying the original 15,000 a year, but now our expenses are 16,250, so the tenant is going to write you a check for $1,250. The differences, the difference between those two numbers. All right. So as you're going through it, your your tenant is going to absorb yours two through six on their end. They're going to write you a check for about $9,500 at a 4% increase per year, based on this example. All right, that makes a massive, massive difference in the long run to the value of the property. All right, so again, it just one, it makes sure that you're never going to hit you know these debt service coverage ratio requirements that could scare the hell out of you, and maybe get your loan called because all of a sudden your property taxes went up. You no longer hit your debt service coverage ratio, whatever. But it's also going to make sure that you're not taking a massive hit in value to the building either. All right, so you can see it's very simple, it's very straightforward. Now these clauses are what can make or break a deal. All right, so the CAM definition and its exclusions. So make sure that you are defining CAM and you understand what is actually in the CAM pool, what is out, when a repair becomes a capital expense. Number two, you want to make sure who repairs and who replaces is very clearly defined. The roof, the HVAC, the structure, the parking lot, like HVAC specifically, I typically require the tenants to replay, to repair and replace. But I, as the landlord, am willing to give them a credit up to $1,000 a year for repairs, replacement, and maintenance. Maybe 1500 a year, depending on how old the unit is. All right, but they have the right to inspect it and make sure that it's a unit that they are willing to take over. Okay, the escalation. You want to make sure that you have a fixed percentage that you can underwrite. Typically, that will beat CPI. The last few years, it has not at all beat CPI. You can tie your rent increases annually to CPI if you wanted to. That means that you would have to sit down and recalculate it every single year to figure out what it is. I like to keep mine simple. I use three to 5% increases per year. That's it. Very simple. I don't have to negotiate it with the tenant. I just say like it is what it is. You know, CPI just opens up a whole can of worms, and then the assignment, the options, the guarantee. You know, who can take the space? What what type of use can take the space if the tenant decides to assign it to somebody else? I got you know, I as the landlord still need approval on whomever's going to take it over because I don't want my doctor's office to become a vape shop. That doesn't make any sense. What the renewal rents are, whose name is on the front, you know, for the rent. So there's a lot of clauses when it comes to these commercial leases that can really make or break these deals. But at the end of the day, they're relatively simple and straightforward. You know, of course, none of this is legal advice. I'm not an attorney, and I don't play one on TV.
Tyler Cauble
But what we've gone through today are going to be the majority of what you, as a landlord, as a commercial real estate investor, are going to be digging into when it comes to your leases. That's what matters the most: who's paying what, and who's covering which expenses, right? In a triple net, the tenant pays, and a gross you pay, and in a modified gross you decide. But make sure that you're always going with a modified gross with a base year expense stop. That is the best type of lease to structure. All right, that's it for today. Let's see. Jim is saying on a triple net lease, who covers plumbing, electrical, storefront, doors, and windows? So typically, as a landlord, you are not going to be responsible for storefront doors and windows, plumbing, and electrical. You will be responsible up into into the space. So basically, from the outside envelope of the space, you are responsible. So for like services that are going from the street to the building, you as the landlord will probably be responsible for the tenant will be responsible for everything inside their walls. That could change, of course, if it's an absolute net lease. You know, obviously the tenant would be responsible for that. But in a triple net lease specifically, that is typically how it is done. Guys, appreciate y'all for joining me. It is we are 30 minutes past, so it's time for me to jump. Like I said towards the the beginning of the show, if you've been enjoying it, you are liking what we are doing. Please like, subscribe, review us on Apple Podcast and Spotify. That way, other people can learn more about the show, and we can get out there in front of other people and teach them more about commercial real estate and how to do this the right way. Appreciate you guys. Hopefully, we'll see some of y'all at the event this week. If not, I'll see you next Tuesday, 830 a.m. Central Standard Time. Cheers. This episode of the Commercial Real Estate Investor Podcast is brought to you by my CRE Accelerator Mastermind, where you'll get access to my step-by-step investment blueprint, essentially a library of resources on how to invest in commercial real estate. You'll get connected to a supportive community of other commercial real estate investors that are doing projects just like you'll get personalized coaching and feedback from me every step of the way. Go to www.crecentral.com to learn more.
Two identical commercial spaces. Same size, same property type, but one is worth $97,222 more because of how the lease is structured.
One rents for $14/SF triple net, while the other brings in $18/SF gross. You'd think the higher rent means a better investment, right?
Not necessarily.