Of the many things you’ll have to pay extra attention to as a real estate owner, agent, or investor, the terms of your arrangement with a tenant sit at the top.
A lease, as it’s commonly known in real estate, is a legal contract in which the renter agrees to part with a specific amount of rent over a certain period of time in exchange for the right to be the tenant of the space.
Rent can take several forms, based on the type of lease in place. Unless you understand what each type presents, it will be difficult to have a clear understanding of things like your property’s financials, potential operating risks, and so on.
Something else worth mentioning is that the structure and terms of a lease have the capacity to affect the property’s operating cash flow and valuation.
Now, looking at the weight leases carry in influencing financial outcomes, among other aspects, you have a lot to gain by learning about them in detail, which we shall do later on in the article.
First, we’ll discuss two of the most common forms rental income take; i.e., gross rent vs net rent plus additional information that may be of help to you as the one renting out space to a tenant.
We’ll begin with the definitions.
Simply put, this is the total amount paid for a rental before subtracting other expenses such as utility and maintenance. The amount can further be broken down into two parts, namely gross scheduled income and gross operating income.
These terms are important to you as a landlord as they help in planning, forecasting, and the general analysis of the property’s performance.
Gross scheduled income, for instance, helps the landlord see the actual rent potential that units of a given property can bring irrespective of whether they are occupied or not. It’s defined as the rent being collected from all occupied units in addition to potential revenue from units not currently occupied.
This figure will help you as a landlord, see areas in which you can improve in order to retain currently renting clients, and perhaps ramp up your marketing efforts in order to fill the vacant units for a higher occupancy and actual returns.
Gross operating income, sometimes also referred to as effective gross income, is the actual rent amount you are collecting from occupied units.
Net Rent/Net Operating Rent
This is the amount that you as a landlord arrive at after subtracting all the property expenses from the gross operating income. Operating expenses are basically the day-to-day expenses that come with operating a property and that includes:
- Property taxes
Although there may be other expenses associated with the property that may be wholly or partially tax deductible such as loan payments, depreciation, interest, and capital expenditures, these are not treated as operating expenditure as they are not part of operating the property.
With this in mind, calculating the net operating income (NOI) becomes very simple because you will only need your gross operating income less the operating expenses as defined above.
On the surface, it does look like only tenants should be concerned about these two terms. But that’s not really the case, as we saw earlier. As the one renting out space, it’s important to know how either of these options can affect you and which is more suitable for your renter.
We break this down for you.
Either option might be suitable depending on what the renting needs of your tenants are. Where gross leases are concerned, the tenant pays a flat rate for exclusive use of the property. You as the landlord may have used previous property data to arrive at a rental figure that covers the rent, standard utilities, and day-to-day expenses.
Gross leases are fairly flexible and can be customized to suit both you and the tenant. For instance, you could come to an understanding with the renter that the flat fee should also include landscaping or waste pick up. Or the gross lease could be modified to not only include the principal provisions of a gross lease agreement but also state that the tenant will take care of electricity utilities, while the landlord will provide janitorial services and waste pick up.
A gross lease is beneficial for a tenant who wants to only pay a flat fee. This is very sound for commercial renting, especially when you are looking to get rid of variable expenses related to the property.
Net leases, on the other hand, are the exact opposite of gross leases. You as the landlord seeks to shift part or all the costs that come with the property to the tenant.
Conventionally, a tenant would pay rent, and the landlord would take care of taxes, insurance, and utilities of the property as in a gross lease. A net lease, however, will shift all or some of these responsibilities to the tenant. This includes maintenance, property taxes, or insurance.
So, if you are opting for a net lease, it would be either of three options below:
- Single Net Lease – In this case, the tenant will pay rent and property tax
- Double Net Lease – This option will have the tenant paying rent, property tax, and insurance
- Triple Net Lease (net net net) – What is net net net? Just as the word suggests, the renter will pay for the net rent, which will comprise of net property tax, net insurance, and net maintenance for the property. This explanation also doubles up as the triple net rent definition.
If your tenant is the kind who wants more control over expenses related to the property, then the above net lease options afford them control to various degrees. It also means added responsibility.
Even though this may be the type of lease a tenant opts for, many landlords will still prefer that renters remit payments to them directly, and they, in turn, make the necessary payments in time like taxes. This usually is to ensure that such fees as property taxes are paid on time and in the proper amounts.
Making a determination over gross lease vs net lease is solely dependent on an individual’s rental needs. For some, a gross lease allows them to pay a flat fee, helping eliminate variable expenses. A net lease, on the other hand, allows one more control over issues like maintenance. The overall operational cost might end up being lower. It does, however, open a person to fluctuation in taxes and insurance costs, which they would be obligated to absorb.
As a landlord, keeping both leases is beneficial as you are likely to have clients who want to rent your property(s) but have different needs. Giving them options allows them to make an informed decision that is in line with their renting requirements.
Given that gross leases are flexible, they can always be modified to reach a consensus that is tenable to both a tenant and you as a landlord.
In general, having a clue about the two rent types and leases we’ve looked at is beneficial not just for you as a landlord but also the tenant. If they seem clueless about this kind of information, it would be great to share it with them. In the end, as the one renting out space, you will get insight on how to maximize profits while your tenants can have some flexibility in choosing options that are suitable to their business or residential requirements.