A modified gross lease is an agreement between a landlord and tenant where the tenant pays for rent and a portion of operating expenses.
Because modified lease agreements are common in commercial real estate, this is an important topic for real estate students to know. To make sure you’re getting the right information, you need to be learning from industry professionals.
Luckily, we’re here to teach you all the facts you should know about modified lease agreements for your real estate career.
In this post, we’ll define modified gross lease, provide examples of how it works, and compare it to other types of commercial real estate leases. Keep reading to learn all the facts!
What Is a Gross Lease?
A gross lease is a contractual agreement where a tenant pays a flat fee for rent plus operating expenses. In a gross lease, the landlord pays for all additional costs such as property taxes, property insurance, and maintenance expenses. The tenant is only responsible for paying rent.
Types of Gross Leases
There are two types of gross leases that real estate professionals must know:
- Modified gross lease
- Full service gross lease
What Is a Modified Gross Lease?
A modified gross lease is a rental agreement where the tenant pays rent plus a share of operating expenses. This type of lease also goes by the name of an industrial lease.
The landlord and tenant both pay proportional shares of operating costs in a modified gross lease. In most cases, the tenant pays for maintenance, repairs, utilities, and cleaning services. The landlord then pays the other operating expenses, such as property taxes and insurance. However, the exact terms can vary depending on the lease agreement.
The rent for modified gross leases is typically lower than that of a regular gross lease. While a tenant’s rent will stay stable over the lease agreement term, the property expenses will be more fluid.
Essentially, a modified gross lease is the middle ground between a gross and net lease.
What Are Modified Gross Leases Used For?
Modified gross leases are popular in commercial real estate. Examples of commercial properties include:
- Office spaces
- Assembly plants
- Retail spaces with multiple tenants
- Industrial properties
Example of a Modified Gross Lease in Real Estate
Imagine that the local mall is renting out commercial property spaces to tenants. The owner of Amy’s Boutique decides that she would like to lease out one of the properties for her shop.
The mall owners and Amy sign a modified lease agreement where she pays for rent plus the following operating expenses:
- Repair and maintenance
Per the agreement, the mall owners are responsible for paying all other operating costs, such as property taxes. This is an example of a modified gross lease agreement, as each party has decided to share a portion of the additional costs.
What Terms Should a Modified Gross Lease Cover?
According to Nolo, any lease or rental agreement should include the following details:
- Name of every tenant who lives in or occupies the space
- Description of the property
- Limitations on occupancy
- The term length of the agreement
- Rent amount, payment method, and payment schedule
- Security deposits and fees
- Maintenance and repair policies
- The landlord’s legal access rights
- Illegal activity restrictions
- Other disclosures and restrictions
Pros and Cons of Modified Gross Leases
Let’s discuss the advantages and disadvantages of using a modified gross lease.
A modified gross lease means landlords have fewer responsibilities, as the tenant shares some of the costs. This makes modified gross leases a safer investment for property owners. However, landlords generally have to offer lower rent prices for these types of leases.
Tenants benefit from modified gross leases because they usually pay less for rent. They can also negotiate which operating expenses they are responsible for in the lease agreement. If tenants agree to pay for utilities, for example, they can lower their costs by using less water and conserving electricity.
The downside of signing a modified gross lease agreement is that the tenant’s bills change monthly. This makes accounting more difficult than if they were only paying one base rent. Tenants also take on more risk with a modified gross lease, as they have more financial responsibility.
See our table for a clear breakdown of the pros and cons of modified gross leases:
|Pros of a Modified Gross Lease for Tenants||Cons of a Modified Gross Lease for Tenants||Pros of a Modified Gross Lease for Landlords||Cons of a Modified Gross Lease for Landlords|
|Base Rent is Lower||Costs May Change Due to Additional Expenses||Lower Risk||Base Rent is Lower|
|Some Control Over Which Operating Expenses They Pay||More Responsibility||Fewer Responsibilities|
|More Room to Negotiate Lease Terms|
Modified Gross Lease vs. Full Service Lease
While a modified gross lease requires that tenants pay a share of expenses, a full service lease requires that the landlords pay for everything. In a full service lease, the tenant pays one flat fee that covers rent and all property-related costs.
Should I Use a Modified Gross Lease or a Full Service Lease?
Tenants interested in paying one fixed price without the headache of extra costs should sign a full service lease. As long as they don’t mind paying a little more for rent, this is the best choice for people who like budgeting their expenses down to the decimal.
For tenants who don’t mind taking on a little more risk for lower rent, a modified gross lease is the superior choice. While they may have to pay a little more than usual some months, they have some room to negotiate the lease agreement terms. For example, if they do not wish to pay for taxes or insurance, they can work this out with their landlord.
Modified Gross Lease vs. Net Lease
In a net lease, tenants pay for rent and additional property expenses. This has many real estate students wondering what the difference is between a modified gross lease and a net lease.
First, it’s essential to know that there are three primary types of net leases:
- Single net lease
- Double net lease
- Triple net lease
Each type of net lease requires the tenant to pay for different expenses. For example, a single net lease requires that tenants only pay rent and property taxes. Meanwhile, a triple net lease requires that tenants pay for rent and all maintenance expenses.
This is different from a modified gross lease, where tenants can negotiate the terms more. Instead of three rigid lease structure options, landlords and tenants can work together to build the perfect contract under a modified gross lease.
What Other Types of Leases Exist?
There are more types of leases that landlords can offer tenants, some of which include:
- Operating leases
- Capital leases
- Bond leases
- Sandwich leases
- Percentage leases
Frequently Asked Questions
Let’s discuss some frequently asked questions real estate students have about modified gross leases.
What Is a Lessor vs. a Lessee in Real Estate?
A lessor, also known as a landlord, is a property owner who rents their space to an individual, family, or business.
A lesser, also known as a tenant, is an individual, family, or business renting a property from a lessor.
Why Are Modified Gross Leases Common in.
Commercial Real Estate?
Small business owners often prefer a modified gross lease because it gives them control without total liability. For example, if a lessor rents out desks in an office building, a tenant can rent a desk without being responsible for the entire building. They can also negotiate which expenses they will pay for, like utilities and cleaning service costs.
What Are Operating Expenses in Real Estate?
Operating expenses are any costs necessary for maintaining and using a property. In a modified lease, tenants have more power to negotiate which operating expenses they will pay.
Examples of commonly negotiated expenses include:
• Real estate taxes
• Insurance premiums
• Maintenance and repairs
• Janitorial costs
• Property management fees
How to Negotiate a Modified Gross Lease?
Most lease agreements are prepared by the landlord to benefit the landlord. However, in a modified lease agreement, tenants should negotiate contract terms since they are paying for some of the property’s operating costs.
Tenants should carefully look over the contract and take the following actions:
• Ask for a lease length that works best for their needs
• Research other commercial rents for comparable rates
• Keep an eye out for hidden fees and costs
• Request favorable clauses, such as improvements to the property
• Read the termination clause closely so they know their rights in the case of an eviction
What to Know Before the Real Estate Exam
A modified gross lease is a rental agreement where the lessee pays for rent and certain operating costs.
Modified gross leases are popular in real estate, so students must understand how they work before the exam. A modified gross lease is a great option for tenants who like more flexibility and the opportunity to negotiate terms.
Of course, you still have much more to learn before passing the real estate exam. Check out our online Real Estate Flashcards to help you study for the big day!