Property may fetch you some amount in rental, it also has running costs. When you look up for assessing the viability of an investment or carrying out a financial appraisal of an investment opportunity you shall take that factor into account.
The running cost generally includes management fees, refurbishment, repairs, maintenance costs, and tax on your rental income. Therefore, to establish the true income, consider these accounts as well. To put it simply, you need to subtract these expenses to know your net rent.
Take the following Example:
If the monthly rental income from a property is $700 per month, we can find out the net rent.
Gross rent = $700
$50 management cost
$50 maintenance costs
Net rent = $550
For seasonal investors, they take into account a gross rental yield as they are able to quickly assess the expected costs. But for inexperienced investors, considering a net rental is better to know they have properly accounted for every expected cost and can only make a judgment based on complete information.
To put it in the mathematical equation:
Net Rent=Gross Rent – (Fees + Tax)
Investors and real estate owners aim to generate revenue from the users of a space. To serve their end, leases are the legal documents commonly used to define the terms of this arrangement.
If you have an idea of what types of leases are there you can exploit that into your favor in understanding the big picture of a property’s financials and potential operating risks. The lease is defined as a legal contract where the tenant agrees to pay a certain amount of rent over a specified period in exchange for their right to occupy a space. You could arrange a commercial real estate lease to make the maximum profit out of your investment.
To educate you on the matter, we have compiled a complete guide of different types of commercial lease structures and their key terms, as well as provide some examples of how these structures and terms can impact the financial performance of a real estate investment
What are Lease Structures?
Leases may vary on the subject as who is responsible for what. Will the burden rest with the landlord to pay operating expenses such as utility bills, maintenance, and janitorial expenses, taxes, insurance, etc or with the tenant.
Based on it, the following are the main categories of leases.
Gross Lease structure:
There are two types of gross lease:
Full-Service Gross Lease:
It is a type of lease structure where the tenant is obliged to pay a fixed rent and the landlord covers estimated operating expenses such as taxes, insurance, utilities, maintenance, and repairs. The tenant is not responsible for the rise or decreased running expenses instead continue to pay fixed rent.
This creates a potential upside for the owner in the case where operating costs end up being lower than budgeted. At the same time, the owner runs the risk of any unexpected increases in property expenses above budget, such as a spike in utility rates.
From the tenant’s perspective, the full-service gross lease is attractive because it can plan on a predictable stream of rent payments. However, there is a potential disadvantage of overestimated costs.
Modified Gross Lease:
If the lease is modified at the discretion of the landlord or tenant or any unique clause is added to the lease, it is a considered modified gross lease.
Gross leases are modified to benefit property owners and/or tenants. Industrial Gross Lease is an example of a modified gross lease. In the typical industrial gross lease, the landlord is responsible for taxes and the tenant is responsible for utilities as well as any increase in property taxes and insurance beyond base year expense calculations.
Net Lease Structures:
1-Triple Net Lease:
The tenant has to bear the proportionate share of property taxes, property insurance, common operating expenses, and common area utilities. In addition to it, tenants are further responsible for all costs associated with their occupancy. The advantage for the landlord is that the burden of running cost is shouldered with the tenant.
From a tenant’s perspective is that in this lease structure, they are asked to pay a lower rent in exchange for assuming the risk associated with operating expense variations.
2-Double Net Lease:
In this setting, tenants are supposed to pay rent plus their pro-rata share of property taxes and insurance. They also bear the cost of a utility in their space. Land takes responsibility for structural repairs and common area maintenance.
3-Single Net Lease:
The tenant is asked to pay rent plus their pro-rata share of property taxes. Besides, the tenant pays utilities and janitorial services associated with their space. The landlord shoulders all other building expenses.
The bottom line:
From an investment point of view, different variations of gross and net leases are widely used throughout commercial real estate. Sometimes, a specific lease term is used if that is the fashion in the area.
Seasonal investors take full advantage of such lease structures because they know the system inside out. By now, you have a fair idea of how different leases are structures and you can use that to your benefit.