The Modified Net Lease in Commercial Real Estate
Landlord and Tenant Negotiate a Split of Expenses
The modified net lease is a compromise between the gross lease and the triple net. The landlord and tenant usually set up a split of maintenance expenses, while the tenant agrees to pay taxes and insurance. Utilities would likely also be negotiated in the modified net lease.
This type of lease might be used in industrial, retail or multi-tenant office properties. Tenant resistance to triple net leases, especially in older properties, makes the modified net lease more popular. It allows a compromise situation that shares the costs of building operation and maintenance.
The terms of a modified net lease are as varied as are building and tenant business types. The flexibility of this lease type makes for easier agreement between tenant and landlord. Many a lease has been put together because of creative modified net lease terms.
Why is this Lease Type Popular?
To answer that question, let's think about the many varied uses for commercial lease space. Business requires profit to continue to exist (unlike government). The business owner spends much time and effort in analyzing their revenues and expenses, as well as their product or service pricing to manage that necessary profit.
- Clothing store: This business owner is concerned about lighting and displays, and that lighting is a major consumer of electricity. Possibly the landlord would want to negotiate utilities with the business. While there is a seasonal component to clothing, the inventory is just adjusted for the season. So, this business owner may want to negotiate a lease that is fixed in amount each month, but share in repair expenses, as there isn't much in the way of repairs in a clothing store space.
- Food Stores or Restaurants: When there is a lot of refrigeration equipment, particularly built-in walk-in coolers, the utilities would probably be something negotiated between the landlord and tenant. Repairs would be on that negotiation list as well, as the tenant may want to share in that expense to get some control. Sharing in the expense would allow the tenant to schedule preventive maintenance to avoid food losses when there are refrigeration failures.
- Light Manufacturing or Assembly: Often the equipment in these businesses belongs to the business, not the landlord, so repairs and maintenance would fall on the tenant. However, depending on the electricity or gas consumption of the equipment, there may be some negotiation of utilities.
- Usage Risk Considerations: Suppose a building has historically been used as a warehouse and the new tenant is going to do some light manufacturing or component assembly. If this changes the insurance hazard profile for the structure, the insurance would go up, and the landlord would likely want to take care of that with a negotiated modified net lease arrangement.
- Usage Zoning Change: Let's use that previous example again. The change in use requires a zoning change or waiver. In getting that approved, the property tax rate for the structure changes. If it goes up (usually likely with taxes), the landlord would probably be looking for some relief.
- Sporadic Occupancy or Use: A tenant rents a warehouse/office building, but will not be there much of the time. It's to be a storage structure with no heating or other significant utility usage when the tenant is away. It may be in their best interest to negotiate and pay the utilities as a trade-off for lower rent.
Those are a few examples, and there are plenty more business types that could benefit from the modified net lease. Both the landlord and tenant are in business to make a profit. A good tenant is valuable, as is a responsible landlord. Sometimes adjusting the length of the lease to go longer will be desired by the landlord, and they may make concessions in other areas of the lease in exchange. Business is a series of negotiations, with customers, vendors, landlords and tenants.