If you are looking to buy a commercial property with a tenant in it, you may have come across the terms “Net Lease” and “Gross Lease”. But what do they mean? Funnily enough they are actually very important terms and will certainly have an impact on the value of the property given that they directly affect the yield to the owner.
Net Lease A net lease requires the tenant to reimburse the landlord for “Outgoings” or “Operating Expenses” of the building or the land for which the premises are a part. Outgoings may include things like rates and taxes, cleaning of common areas, electricity to the common areas, security, management and repairs.
Generally, where there are multiple tenants within the building, the tenant will pay a proportion of the total outgoings. The proportion is usually (but not always) calculated by dividing the lettable area of the Premises by the lettable area of the whole building.
Gross Lease Under a gross lease, the Tenant is only required to pay the rent. It is up to the landlord to ensure that things like land tax and water rates are paid. The landlord will generally have no recourse to claim such amounts from the tenant. That said, when a landlord and tenant negotiate the rent for the property, naturally under a gross lease the rent should be higher to take into account the landlord’s requirement to pay outgoings.
As with most things the appetite for risk between the landlord and tenant will have a bearing on whether they enter into a gross lease or a net lease. This flows on through the conveyancing process to a purchaser of the land. If a tenant enters into a net lease, the tenant has no certainty or indeed control over the amount that it will have to pay for outgoings. On the other hand, if the tenant enters into a gross lease, it will have certainly over the amount paid to the landlord each month but as there is less risk, the landlord is probably going to increase the rent at the commencement of the lease to ensure that he or she is covered against unforeseen rises in outgoings throughout the term of the lease. Of course as you conduct your due diligence and as part of the conveyancing process, as a purchaser you will have to assess your own risk appetite.
As part of the conveyancing transaction, it is imperative that you understand whether the tenant of the property you are looking at buying is under a Gross Lease or a Net Lease. You will then need to adjust your negotiation technique accordingly. It is not unusual for the lawyers here at ClickLaw to be advising on the acquisition of a commercial or retail property only for the purchaser to have been under the impression that the lease was a gross lease when in fact it is a net lease and vice versa. This certainly has an impact on the price that should be paid and the calculations that should be undertaken in relation to the purchase of the property.
Finally, just to throw a cat among the conveyancing pigeons, some leases provide for a gross lease but also provide for increases in outgoings above the base figure used to calculate the gross rent. The tenant must then reimburse the landlord the amount of the relevant increase. Such a lease is often referred to as a semi-gross lease.
If you have any queries in respect of the leasing or conveyancing process and legals behind such processes, please do not hesitate to call one of the expert property lawyers here at ClickLaw.
John Kettle
Principal Lawyer
ClickLaw Australia