NNN vs Gross for Commercial Office

13 Replies

Which would you say is best for a property owner on a commercial class B office building and why?

The property in question is currently on NNN leases, the thought came up today to transition everything over to Gross leases.

I personally think that the leases should be left alone as NNN.

I understand the differences between the two lease formats. I'm wondering if one format is better than the other for an office property, and why.

On gross leases, you can make more money if you can control costs better than your tenant, and original gross rent is based on tenant costs. Most people would prefer NNN as you know what you are going to make, but if you have a great management team, then gross could be the way to go.

Some buildings are more suited to NNN and other buildings more suited to gross. The fewer tenant spaces there are, the better your chance for a successful triple net. I think Mark is right on, if you can control expenses better as an owner than your tenant can, then gross will make you more money.

In the long run,  I prefer triple net, just because it is so hands off.

I should add that this property comprises of two six story multi-tenant towers that are about 135k SF each. The Landlord controls all expenses.

Originally posted by @Mike Giudici :

I should add that this property comprises of two six story multi-tenant towers that are about 135k SF each. The Landlord controls all expenses.

 How many tenants?

I can't recall seeing a NNN multi-tenant six story building before.

about 30 tenants

@Mike Giudici   it sounds like it depends on the market how prevalent triple net is compared to gross leases.  I've managed multi-tenant mid rise office buildings that were triple net in Ft. Lauderdale and Hollywood, FL and I'm pretty sure it was the same in Miami for high rises.  One of the midrises had in-house electricty sub-meters (EMON) so the tenants were individually billed electricity on top of common area and parking lot lights. Boston has multi-tenant high rise triple net office space with onsite managers.  

When I say triple net, it was full pass through of expenses controlled by the building management team.  Tenants were billed their pro rata share (CAM, TAX, INS) but the tenants were responsible for repairs in their spaces with the exception of HVAC.

I would say, if the tenants are already accustomed to NNN why change it? The downside of gross leases is that you lose profits when some expenses rise if you don't have any expense cap pass through clauses in your leases. Massachusetts is seeing a 37% rate hike in electricity from National Grid. Couple that with a property tax hike (which Worcester did this year) and you're totally squeezed.

If you DO go the gross lease route, make sure you are protected from this scenario in your leases.

*with the exception of HVAC and fire/life safety systems.  Not all of these buildings were structured this way.  In some cases our engineers made repairs in tenant space.

This property is set up the same way.  We sub meter and resell utilities and pass through all  expenses. 

The idea of switching to gross leases was brought up because it would be easier to handle administratively and from an accounting standpoint. I agree with that, but I feel that by making the switch you suddenly become exposed to fluctuations in operating expenses. In addition to loosing the ability to pass through traditional operating expenses, we also loose the ability to pass through staff and certain capital improvements to the property. 

The unexpected fluctuations in operating expenses in a gross lease scenario can reduce the properties NOI and negatively impact property value.

it sounds like you have a pretty good case to leave the leases NNN, IMO.

Yeah Mike there are varying answers depending on who on the team you talk to.

Everyone is looking at it from their view and making things easier for themselves.

"The unexpected fluctuations in operating expenses in a gross lease scenario can reduce the properties NOI and negatively impact property value."

This is exactly why I like absolute NNN.

Most of my clients want NNN. They are exiting the stock market because they do not like stomaching the fluctuations. With the gross leases they would be worrying about the exact issue you describe above.

@Jon Klaus Can you tell us why some buildings are suited for NNN and some for Gross? Maybe with a couple examples :) Thanks!

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