How do you choose a lease type to maximize cash flow?

I am a firm believer cost are manged if the tenants pay for utlities. They have a choice to conserve. If they do not see a bill monthly the pay little attention to conservation.

Gross Lease with base year cost escalators for real estate taxes and operating costs as well as an annual negotiated fixed increase or one based on the Consumer Price Index can work wonderfully. If your costs go down you garner 100% of those savings.

There is a conundrum in that the Landlord often has an agent acting for them and the Tenant (even a very business savvy Tenant) may not have the skills to negotiate the Heads of Terms. Before finalising the Head's of Terms - speak to your commercial property solicitor. Ask them to help with the HOT's. It will save all parties time in the long run and you can discuss repairing obligations, covenants, insurance provisions, security of tenure, rent deposits, service charge and the myriad of other sections that form a balanced lease. For maximum cash flow - getting help so you get your rent depost back before the end of the term, delaying first payments (or not having them at all), making sure the space can be split are all great starters.

What is it? In a gross lease, the landlord covers all the property expenses, including taxes, insurance, and maintenance from the rent received. Pros: Predictable monthly expenses for tenants. The landlord handles all property-related costs. Cons: Typically higher monthly rent since costs are bundled.

Gross Leases are problematic to Landlords and tenants here are a few examples; For a tenant, annual escalation is calculated on net rent and outgoings which can escalate outgoings at a higher rate than the actual increases and there is a lack of transparency. For a Landlord when outgoings are increasing at higher rates that than the escalation rate net rent is decreasing.

So the best possible Lease, I feel is the Net Lease or NNN as the tenant pays for operating expenditure, it is better in large commercial buildings with multiple units, where the entire management is taken care of by the Building Management Team. Also in case the Investors need to sell the property it is more easy to calculate the ROI

A NNN lease is often times associated with a single tenant in Ground Lease where the landlord has minimum responsibility and tenant bears all costs including structural repairs and replacement. A landlord NN lease is where the landlord is responsible for maintaining the structure and often times allowed to pass through an amortized portion of capital costs to the tenant over the remaining lease term. This is a nutshell description; the lease either way is heavily negotiated in defining costs and risk bearing factors.

What is it? Here, the tenant pays some or all of the property expenses. It's broken down into three types: a. Single Net Lease (N Lease): Tenant pays rent + property taxes. b. Double Net Lease (NN Lease): Tenant pays rent + property taxes + insurance. c. Triple Net Lease (NNN Lease): Tenant pays rent + property taxes + insurance + maintenance. Pros: Potentially lower base rent for the tenant. Cons: Variable costs; tenants need to budget for additional expenses.

The best type of lease for both tenant and landlord. The Landlord can set a net return and escalation rate on the property and know that this ROI will be maintained for the duration of the lease. The tenant gets total transparency on costs and what they are paying for.

The NNN lease usually still holds the Landlord responsible for Structural repairs and Roof Replacement. The NNN is usually a pro-rata share in a shopping center environment where each Tenant pays their share of Taxes, Insurance, and Repairs. The landlord absorbs the cost for vacancies. All of that being said, what is or is not covered under the NNN is negotiable.

Another lease type that can work; but generally manageable if your systems can account for specific pass through costs lease by lease; as a general management of leases and billings; this can be a time suck if you’re leases are not consistently the same in regards to identifying what costs are passed through.

What is it? A blend between Gross and Net Leases. The tenant and landlord decide on the shared responsibility of property costs. Pros: Flexibility; both parties can negotiate terms that suit them best. Cons: Less predictable than a full service lease; terms might be complex.

There are many variations on a theme with this type of lease they are often too complicated difficult to negotiate and almost always result in either the tenant or landlord being compromised in the long term.

This can be a win-win for both Landlord and Tenant. Often times if the negotiations stall on an NNN lease, this can be the answer. Sometimes Tenants want more services then the Landlord is willing to pay for but has no problem providing, this is a lease that can settle those differences.

Can be a home run for a Landlord with major restaurant chains or QSRs; however smaller mom & pop operations where cost containment is more difficult is a double edged sword as they struggle with increasing sales to cover cost increases only to find themselves having to pay more rent with less of a bottom line. Be smart as a landlord to know that a successful restaurant can increase foot traffic to a center and raise all the revenues for your other tenants. Happy tenants = Happy owners

What is it? The tenant pays a base rent + a percentage of monthly sales over a certain threshold. Pros: Could be beneficial for businesses with fluctuating sales. Cons: The landlord has an interest in the tenant's sales figures, which some businesses may not prefer.

Tenants generally hate this type of lease, as it is unfair to tenants. I believe Landlords should be sticking to renting property, this type of lease gets you involved in your tenants business, which a Landlord knows nothing about and is not entitled to participate in, and can impact your tenants profitability. This type of lease is not good for either party.

This works well when a Landlord is trying to drive traffic to a site. Recently in a very vacated mall I was successful in filling up the Food Court with Percentage Leases which in hand drove traffic to not only the other Tenants but the other vacancies as well. A smart Landlord will consider this when trying to revive a property.

An important consideration is whether or not the owner intends to sell the property in the future. If it is to be sold as an investment property, the owner would probably be best of, having a triple net lease in place. Investors typically will favor an investment with a predictable income and little additional expenses or efforts as the owners. Consider an investor choosing between a bond and an investment property. If the investor can simply invest in bonds for the same return with no additional effort, why would they choose the real estate option? Structuring the leases as longer term triple net lease helps makes these options more comparable.

Low Margin Business: businesses with thin profit margins benefit from predictable expenses. A gross lease, which offers a fixed monthly cost adjusted only for inflation, would be ideal for such businesses. The predictability allows to budget and plan effectively without sudden shocks to their cash flow. Startup vs Established Business: For startups, cash flow is often unpredictable, and they may not have a clear idea of their maintenance or operational costs. In such cases, a gross lease or modified gross lease might be more beneficial since it provides more predictable costs. An established business with a better understanding of its expenses might opt for a net lease to potentially lower its base rent.

Landlords need to set a ROI, achieve rent growth and capital appreciation that is acceptable to all stakeholders. Tenants are concerned with growing their business, increasing margins and reducing costs. At first glance tenants and landlords interests appear to be diverging, and this is where a broker plays a vital role negotiating a lease that is fair and reasonable for both parties, which determines the type of lease that is chosen.

understanding the nature of your business, your appetite for risk, and your ability to handle variable costs is essential when choosing the right commercial lease type. Engaging with a commercial real estate expert can also provide clarity, ensuring the lease type aligns with the business's long-term goals.