In commercial real estate leases, the operating expense structure defines how costs related to running and maintaining the property are allocated. These expenses typically include property taxes, insurance, maintenance, repairs, and utilities. Depending on the lease terms, tenants usually pay a portion of these costs in addition to base rent.
The way operating expenses are structured can directly affect the total rent paid throughout the lease term. For example, two identical buildings side by side—one under a triple net (NNN) lease and the other under a base year lease—can result in very different overall tenant costs.
It’s important to note that industry terminology can vary. Different real estate professionals may use different names for similar structures. Below is an overview of the most common operating expense structures you’ll encounter:
Triple Net Lease (NNN)
In a triple net lease, tenants pay their share of all property operating expenses, including property taxes, insurance, and maintenance. This means the tenant covers most of the variable costs beyond base rent.
Base Year Lease
A base year lease sets the tenant’s base rent based on the property’s operating expenses during a specific base year—usually the first year of the lease. The tenant then pays for any increases in operating expenses above that base year amount. Click here for a more detailed breakdown of this lease type.
Gross Lease
Under a gross lease, the landlord pays all operating expenses. The tenant pays a fixed rent that includes these costs. While less common in commercial real estate, gross leases are preferred by tenants who want predictable monthly payments and by landlords managing less complex properties.
Modified Gross Lease
A modified gross lease blends features of both triple net and gross leases. The landlord and tenant agree on a base rent covering some operating expenses, such as property taxes and insurance. Other expenses, like maintenance and repairs, may be passed on to the tenant, sometimes with a base year applied.
Absolute Net Lease
An absolute net lease requires the tenant to pay all operating expenses plus any structural repairs or replacements during the lease term. This lease type is common in single-tenant buildings, where the tenant assumes maximum responsibility.
Expense Stop Lease
Similar to a base year lease, an expense stop lease specifies a cap on operating expenses included in the base rent. When expenses exceed this “stop” amount, tenants pay the overage. Expense stop leases are less common but still used in some agreements.
The below table provides a simple overview of the operating expense cost a tenant might expect over a five year term under different lease structures. In this example, the first year expenses are $10.00 per square foot and increase at 5% per year.
Why Understanding Operating Expense Structures Matters
The operating expense structure can significantly impact your total rent and budget planning. Each structure has unique advantages and disadvantages. Tenants should carefully negotiate lease terms that align with their financial goals and risk tolerance.
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