Modified Gross Lease: Definition & Examples

It takes attention to detail to understand modified gross leases for commercial real estate. People often categorize the lease as a full-service gross lease or a triple net lease, but most of the agreements out there fall into the middle of the spectrum, often referred to as a modified gross lease agreement. Ultimately, the landlord and tenant share the property's operating expenses.

For example: In a building where the total monthly electric bill is $1,000, if there are 10 tenants, each might pay $100, or their share might be based on the square footage of their unit.

Key Takeaways

• Shared Costs: The tenant pays base rent plus a share of some operating expenses.
• Common in Commercial Real Estate: Particularly in multi-tenant office buildings.
• Negotiable Terms: Specific expenses covered by the tenant or landlord varies.

How a Modified Gross Lease Works

A modified gross lease is a lease structure where the landlord and tenant are responsible for paying the property’s operating expenses. The specific operating costs that a tenant pays or a landlord pays under the modified gross lease (MGL) can vary. This variation is because of negotiations between the tenant/landlord and the market conditions.

In some cases, the tenant may cover a portion of the insurance costs, while the landlord pays the remaining insurance costs. As an example, the tenant may be responsible for expenses directly related to the unit, such as utilities and janitorial services, while the landlord covers common area maintenance and property insurance.

The only way to know who is responsible for paying each expense is to establish those details in the lease agreement.

Pros and Cons of Modified Gross Leases

There are many pros and cons of modified gross leases for tenants and property owners, let's discuss these below.

Tenants

Pros:

• Predictable budgeting for specific expenses.
• Reduced responsibility for building-wide costs.

Cons:

• Dependence on landlord for maintenance quality.
• Potential for higher shared costs in poorly managed buildings.

Property Owners

Pros:

• Assurance of maintained property standards.
• Flexibility in expense recovery from tenants.

Cons:

• Risk of undervaluing operating costs.
• Potential disputes over shared expense calculations.

Modified Gross Lease Examples

Basic Example: A tenant occupies 10,000 square feet in a100,000 square foot building. If total expenses are $1 million, the tenant pays 10% ($100,000).

Flat-Dollar Contribution: A tenant might pay their pro-rata share of real estate taxes and insurance while contributing $1 per square foot annually for structural repairs.

Expense Stops: The landlord covers expenses up to a predetermined limit, known as the expense stop, after which the tenant is responsible for any additional costs. For instance, with an expense stop set at $1 per square foot (SF), the tenant pays any costs that go beyond this amount.

Imagine a building with $100,000 in property taxes and $25,000 in insurance. If these expenses are grouped and the total per square foot exceeds the $1/SF stop (e.g., total expenses amount to $1.25/SF), the tenant would pay the excess $0.25/SF based on their proportional share of the space.

Base Year Stop: Expenses are compared to a base year amount. The tenant pays for increases above the base year cost. If the base year expenses were $100,000 for a 10,000 SF building, the base amount is $10/SF. The tenant pays any excess in subsequent years.

Base Year Stop vs. Modified Gross Lease

In the examples above, one example was the base year stop. A base year stop is similar to other expense stops but uses the expense amount from the base year of the lease.

For example, if base year expenses were $100,000 for a 10,000 SF building, the base amount is $10/SF. The tenant pays expenses exceeding this amount. Typically, the base year aligns with the calendar year the lease starts.

If a lease begins in August 2024, the base year is January to December 2024. Alternatively, the base year could match the tenant’s first lease year (e.g., July 1, 2024, to June 30, 2025).

Comparison with Other Lease Types

Gross Lease

In a gross lease, the landlord's responsibility is all operating expenses, including property taxes, insurance, and maintenance. This can be beneficial for tenants who prefer predictable costs but can result in higher rent to cover the landlord's expenses.

Single Net Lease

A net lease requires the tenant to pay base rent plus all property operating expenses. This structure is common in single-tenant buildings and can appeal to landlords seeking minimal involvement in property management.

Double Net Lease (NN)

A double net lease (NN) is a type of commercial real estate lease agreement where the tenant is responsible for paying two of the three primary property expenses in addition to the base rent. These two expenses typically include property taxes and property insurance premiums, while the landlord remains responsible for structural maintenance costs.

Triple Net Lease (NNN)

A triple net lease (NNN) is a type of commercial real estate lease agreement where the tenant is responsible for paying all three primary property expenses in addition to the base rent. These three expenses typically include property taxes, property insurance, and maintenance costs.

Commercial Real Estate Leases

Ultimately, there are two types of commercial real estate lease options - absolute gross leases and the absolute net lease. With the absolute net lease, the operating expenses get paid by the tenant. However, with a gross lease, the landlord pays for all of the operating costs for the property.

Any other agreement falls in the middle, and they are often called modified gross leases. A modified gross lease, sometimes referred to as a modified net lease, incorporates characteristics of both a gross lease and a net lease.

Read the Lease Agreement

The most important part of understanding the commercial real estate lease agreement is to read it thoroughly.

You may see descriptive terms, such as net lease, gross lease, and double net lease; they can be good starting points. However, to know if you have a modified gross lease, you must go through each point carefully.

Understanding the lease agreement is crucial because it outlines the responsibilities related to property ownership, including which expenses are borne by the tenant and which by the landlord.

Usually, property insurance and property tax are always handled by the property owner. Then, it’s the tenant’s responsibility to cover any property expenses outlined in the agreement.

Gross Lease vs. Modified Gross Lease

A full-service gross lease means the property owner covers all operating expenses, making it simpler for tenants.

In contrast, a modified gross lease splits operating costs between the landlord and the tenant, with terms specified in the lease agreement.

Modified gross leases can get complicated and vary by situation, so we always recommend seeking legal advice. The choice between a gross lease and a modified gross lease depends on market conditions and the specific agreement.

Deciding who pays for operating expenses like property taxes can be confusing. While tenants often dislike triple net leases due to higher responsibilities, modified gross leases offer a balanced approach, benefiting both the owner and the tenant.  Understanding the lease details is important to determine who pays for what.

Always review the agreement thoroughly before signing to ensure it meets your needs and clarifies expense responsibilities.