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THERE IS RENT, AND THEN THERE IS ADDITIONAL RENT: The uncertain nature of rent in some commercial leases

January 23, 2019

By:  LaVonne Torrence Berner

 

When deciding whether or not to lease an apartment, one can usually be certain that the advertised rent reflects the entire amount to be paid to the landlord each month. The landlord charges a flat rate intended to cover all of the landlord’s costs of operating the rental. In this instance, the landlord assumes the risk of operating, maintenance, taxes and other costs that exceed revenues from rent.

 

In a commercial lease, the opposite usually applies. Most leases include a net rent structure (sometimes referred to as NNN or triple net), where rent does not reflect (or is net of) the landlord’s operating expenses (including common area maintenance (CAM), repairs, and utilities), real estate taxes, and insurance. Hence, rent is net of these three lines of expenses, and the tenant pays a separate charge to the landlord to cover the expenses.  

 

The separate charge may be billed to the tenant once per year after the landlord knows its exact costs. But more likely, the landlord will require the tenant to pay a monthly amount based on the landlord’s estimate of actual costs. Once the landlord knows its actual costs, the landlord will reconcile the costs with the tenant’s estimated payments, and the tenant is either billed an additional amount because estimated payments were too low or issued a credit because the estimated payments exceeded actual costs. The reconciliation usually occurs once per year.

 

As you can see, net leases may result in hefty additional rent and expenses that are both unforeseen and uncontrollable by the tenant. To soften the blow and avoid surprises, tenants may want to keep the following in mind.

  • The exact rent structure varies from lease to lease and the type of property being leased (e.g., office vs. retail).
  • The tenant should know whether quoted rent is gross of the landlord’s operating expenses, taxes, and insurance (i.e., the tenant pays a flat fixed rate regardless of the landlord’s expenses) or net of landlord’s expenses (i.e., tenant pays a separate amount to landlord, which may fluctuate based on the landlord’s actual costs).
  • If the lease is net of the landlord’s expenses, the tenant should obtain current expense estimates and the actual expenses over the last few years.
  • To the extent possible, tenants should work with their broker or attorney to negotiate terms that help with the unforeseeable/uncontrollable nature of NNN rent.
  • In addition to rent payable to the landlord for operating expenses, taxes, and insurance, tenants may still be required to carry separate insurance, pay for maintenance and repairs within its space, and pay its own taxes and utilities.
  • Tenants should have a full understanding of its obligations under the lease, BEFORE the lease is signed. Once the lease is signed, it is a binding contract, and the terms of the lease are binding. 

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