What is a Modified Gross Lease?
A Modified Gross Lease (or MG) is a lease where the Tenant and Landlord share responsibility for the payment of certain property expenses. The typical expenses for a commercial property fall into one of three categories.
These three property expense categories are called NNN expenses. The three NNN expenses are the following: N: Real Estate Taxes, N: Commercial Building Insurance, and N: Common Area Maintenance (or CAM).
Be careful: Many people, including seasoned commercial property owners, business owners, and brokers use the term CAM expenses when they are referring to NNN expenses. CAM is just one of the three NNN expenses.
It is easy to understand how much real estate taxes are. This is an annual amount determined by the local taxing authority. The building insurance amount is relatively easy too. This is the amount that the insurance company charges for building insurance.
Common Area Maintenance, or CAM, is the most difficult expense to determine because every property owner has a different formula for determining the amount. Typical CAM expenses include the following: lawn care, snow removal, building repairs, atrium and hallway maintenance, roof maintenance, parking lot maintenance, property management costs, and the list could go on and on. Some property owners keep the CAM expenses simple, while others through the proverbial kitchen sink into the expense account.
What are the Different Commercial Lease Types?
The most common lease types are Triple Net Lease (NNN), Gross Lease, and Modified Gross Lease.
In a Triple Net Lease, the Tenant is responsible for the property’s expenses. These include Real Estate Taxes, Building Insurance, and Common Area Maintenance (CAM).
In a Gross Lease, the Landlord is responsible for all of the expenses.
In a Modified Gross Lease, some expenses are the Landlord’s responsibility and some are the Tenant’s responsibility.
What are some Commercial Lease Type Examples?
In a Triple Net Lease (NNN), all of the property expenses are ADDED to the tenant’s base lease rate.
All of the expenses are calculated on a pro-rata share basis. If the building is 100,000 SF in total size and you lease 10,000 SF, your pro-rata share would be 10% of the property’s total expenses.
For example, if a Tenant has a base lease rate of $10.00/SF and NNN expenses of $6.00/SF, then the tenant’s full lease rate is $16.00/SF. You simply add the base rate and the NNN rate to determine the annual lease rate.
Keep in mind, when you see lease rates quoted per square foot ($/SF), this is an annual lease expense. So, in our example, if a Tenant leases 10,000 SF at $16.00/SF, the Tenant’s annual lease expenses is $16.00/SF x 10,000/SF = $160,000/yr. The monthly lease rate is determined by dividing the annual lease expense by twelve. $160,000/12 = $13,333.33 per month.
Modified Gross Lease:
In a Modified Gross Lease, the Landlord will be responsible for at least one of the NNN expenses, and sometimes two. So for example, in our scenario above, a Landlord could offer space at $12.00/SF MG (Modified Gross). The Landlord may state that they will be responsible for the real estate taxes. In this example, the Tenant would be responsible for Building Insurance and CAM. The estimate for annual building insurance and CAM could be $4.00/SF.
In this example, the rent calculation would be $12.00/SF + $4.00/SF = $16.00/SF. As you can see, the overall lease rate remains the same at $16.00/SF. The difference is in determining responsibility for payments, rather than the lease rate itself. This isn’t always the case, but it can be an important differentiator.
For example, what if the city in which this example property exists decides to redo sidewalks or repave the road? The city may impose a special assessment on the property owner, which is typically considered a tax. This could create a substantial increase in the property’s taxes. If the building owner is responsible for taxes and not the tenant, then this added expense needs to be paid for by the building owner and not the Tenant. This could save the Tenant lots of money and cost the building owner the same.
What are the Benefits of a Modified Gross Lease?
Firstly, both Tenants and Landlords must review an entire lease to determine the full benefits and detriments. All leases are typically negotiable and every section and every word matters. You should consult with a real estate attorney when reviewing a commercial lease and before signing the lease.
Moving on, the example above about a Tenant saving money on unexpected real estate taxes is one benefit of a Modified Gross Lease. A Tenant could also save money if the Landlord is responsible for any unforeseen increases in building insurance or CAM.
Landlords can also benefit from Modified Gross Leases. Some tenants, such as municipal tenants or non-profits have a requirement to cap lease expenses due to funding caps. These tenants often need a Gross Lease but in some cases, a Modified Gross Lease will satisfy their requirements. To keep their properties fully leased, many Landlords will structure their leases to accommodate the Tenant’s requests.
What are the Detriments of a Modified Gross Lease?
Whether you are a Tenant or a Landlord if property expenses go up, and you are responsible for them, this can cost you money. Structuring a lease is all about risk mitigation. Many Landlords prefer NNN leases because all property expenses are the responsibility of the Tenant. This can lower risks substantially for the property owner.
Many commercial properties are also bought and sold as investment properties. Investors prefer NNN properties due to property expenses being the responsibility of the Tenants. If a Landlord has Gross Leases or Modified Gross Leases with Tenants, this can make it more difficult to sell the property as an investment.
From a Tenant’s perspective, if you sign a Modified Gross Lease you are taking on the risk of some of those property expenses going up and being responsible for their increase in payment.
Are Modified Gross Leases Always Available?
No. Many commercial property owners prefer Triple Net Leases. The type of lease structure is often negotiable, but for some commercial property owners, this is a non-negotiable item. This is especially true for investment property owners. Many commercial real estate investors simply want a reliable income stream and they are not interested in being responsible for property expenses or the costs of managing their properties.
Should I Consider a Modified Gross Lease?
From a Tenant’s perspective, a Modified Gross Lease can be an attractive lease type as it keeps the responsibility of some expenses with the Landlord. Both a Tenant and a Landlord are trying to mitigate expense risks. No one wants an unexpectedly high bill for anything.
The Modified Gross Lease is a way for a Tenant and Landlord to find some middle ground on property expenses. The Gross Lease puts all of the property expense risks on the building owner. The Triple Net Lease (NNN) puts all of the property expense risks on the Tenant. The Modified Gross Lease (MG) splits the expense risks between the Landlord and Tenant.
Both Tenants and Landlords should consider a Modified Gross Lease if it leads to a lease agreement that both parties are comfortable with.