When is a gross lease actually a gross lease?

27 Oct 2020 03:23 PM

In commercial leasing, the difference between a gross and a net lease is often confusing, largely because the word ‘Gross’ can be a catch-all for multiple ways leases are structured. 

Here at Lpc Cresa, we were recently engaged by a client with 30 leased sites across Australia, who were looking for help to manage their existing sites and future leasing strategy. When we analysed their leases, a key finding was that they had entered into a number of gross leases and that the level to which outgoings were included in the rent varied from lease to lease. As a result, their annual increases in occupancy costs were above what they had anticipated, as they did not anticipate increases in outgoings for their ‘Gross’ leases. This highlighted the risk of not understanding the impact different structures can have on annual adjustments to occupancy cost.

To get to the bottom of the confusion and manage risk, it’s worth taking a close look at outgoings, utilities, tenant-specific costs, and the different types of lease structures that one can sign up to.

What do outgoings include?

Outgoings refer to a landlord’s reasonable costs of ownership for the building. Outgoings include council rates, water rates, land tax (NOTE: in some states, such as South Australia and Victoria, Land Tax cannot be passed on to tenants except in certain circumstances), insurance, air conditioning, common area cleaning, common area electricity, fire protection, lifts & escalators, repairs & maintenance, security, management, and promotional levies (common in retail shopping centres).  For smaller standalone buildings or different asset types (office, retail, industrial), not all of these will be applicable. Other landlord expenses such as structural capital works and leasing costs for vacant spaces cannot be passed on to tenants, with the exception of capital works under some limited lease structures not usually encountered by the average tenant. 

What do outgoings exclude?  Utilities and tenant costs

What outgoings don’t include are the utilities and tenant-specific costs associated with a tenant’s consumption or their direct usage of the tenancy. These can include electricity consumption, water consumption, internet and data, cleaning your own tenancy, repairs and maintenance of your fit-out, tenant public liability insurance, servicing and maintenance of wall-mounted and supplementary air conditioning units, servicing or replacing fire protection equipment such as extinguishers or fire blankets.

How are outgoings passed on to the tenant? 

With clarity on what outgoings include and exclude, one can better understand the difference between a gross and net lease and the variations of each. The 3 most common types of leases are:

- Net lease
- Semi-gross lease, and
- Gross lease (sometimes referred to as fully gross). 

With a Net lease, a tenant is responsible for rent, plus all outgoings in addition to this rent. 
In the case of the Gross lease, all outgoings are included in the rent.

The problem is that it is rare to see a gross lease which truly includes all of the outgoings and that these leases are often better described as semi-gross leases. This is the common source of over-stated expectations for a tenant when they find their annual occupancy costs increase by more than the prescribed annual rental increase.

There are 2 ways a semi-gross lease will be structured: 

1. Increases over a base year – under this structure, outgoings are included in the rental, but a tenant will pay for increases in outgoings. For example, in Year 1 of a lease, the rental for a tenant’s office building is $50,000 per annum. In Year 2, the outgoings of the office they occupy increase from $10,000 to $12,000. As a result, in Year 2, the tenant now pays $52,000 per annum ($50,000 plus $2,000 in outgoings).

2. Specific outgoings only – under this structure, only specific outgoings are payable by the tenant. There is no standard format for this, and it will differ from one property to another. Examples include a tenant paying a rental plus only council rates and water rates. For example, a rental of $48,000 plus outgoings of $2,000 per annum

What to watch out for?

As with most agreements, ‘the devil is the in the detail’. This is certainly the case when one is considering signing up for a gross lease.

How can Lpc Cresa help?

At Lpc Cresa, we help tenants across Australia and New Zealand with their commercial real estate needs, including transaction advisory, portfolio management and project management.  In summary, we make sure tenant interests are protected and that our clients enter into tenant-friendly lease agreements.

 

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