Modified Gross Lease

What Is a Modified Gross Lease?

A modified gross lease is a type of real estate rental agreement where the tenant pays base rent at the lease's inception, but it takes on a proportional share of some of the other costs associated with the property as well, such as property taxes, utilities, insurance, and maintenance.

Modified gross leases are typically used for commercial spaces such as office buildings, where there is more than one tenant. This type of lease typically falls between a gross lease, where the landlord pays for operating expenses, and a net lease, which passes on property expenses to the tenant.

All agreements should be carefully reviewed by both parties. Even if the lease uses common terminology, it should be treated as though it's a unique document for your own situation.

How a Modified Gross Lease Works

Commercial real estate leases can be categorized by two rent calculation methods: gross and net. The modified gross lease — at times referred to as a modified net lease — is a combination of a gross lease and a net lease.

Modified gross leases are a hybrid of these two leases, as operating expenses are both the landlord's and the tenant's responsibility. With a modified gross lease, the tenant takes over expenses directly related to his or her unit, including unit maintenance and repairs, utilities, and janitorial costs, while the owner/landlord continues to pay for the other operating expenses.

The extent of each party’s responsibility is negotiated in the terms of the lease. Which expenses the tenant is responsible for can vary significantly from property to property, so a prospective tenant must ensure that a modified gross lease clearly defines which expenses are the tenant’s responsibility. For example, under a modified gross lease, a property's tenants may be required to pay their proportional share of an office tower's total heating expense.

When Modified Gross Leases Are Common

Modified gross leases are common when multiple tenants occupy an office building. In a building with a single meter where the monthly electric bill is $1,000, the cost would be split evenly between the tenants. If there are 10 renters, they each pay $100. Or, each may pay a proportional share of the electric bill based on the percentage of the building’s total square footage that the tenant’s unit occupies. Alternatively, if each unit has its own meter, each tenant pays the exact electrical expense it incurs, whether $50 or $200.

The landlord may generally pay other costs related to the building under a modified gross lease such as taxes and insurance.

Pros and Cons of Modified Gross Leases

Like any other business transaction, there are both pros and cons to modified gross leases for tenants and landlords.

Tenants

Since maintenance and other related costs are borne by the landlord, the tenant stands to benefit. The tenant has more control over budgeting for costs directly related to its business including rent, business taxes, salaries, etc. But if the landlord is lax in general maintenance, this may be a problem for tenants, especially those who rely on the appearance of their office or retail space to allure and retain clients.

Landlords

By using a gross modified lease, landlords can rest assured their property is maintained to the degree they see fit, especially since some tenants may not be as reliable when it comes to doing repairs or improvements such as maintaining the exterior space. One disadvantage, though, is undervaluing the operating costs. So a landlord may be in trouble if the rent they charge is too little for a space that requires a lot of upkeep.

Gross and Net Leases

Gross Lease

Under a gross lease, the owner/landlord covers all the property’s operating expenses including real estate taxes, property insurance, structural and exterior maintenance and repairs, common area maintenance and repairs, unit maintenance and repairs, utilities, and janitorial costs.

Landlords who issue gross leases typically calculate a rental amount that covers the cost of rent and other expenses such as utilities, and/or maintenance. The amount payable is normally issued as a flat fee, which the tenant pays to the landlord each month for the exclusive use of the property. This can be beneficial for a tenant because it allows them to budget properly, especially when they have limited resources.

A net lease, on the other hand, is more common in single-tenant buildings and passes the responsibility of property expenses through to the tenant. Net leases are generally used in conjunction with tenants like national restaurant chains.

Many commercial real estate investors who purchase properties, but don't want the aggravation that comes with ownership, tend to use net leases. Because they pass on the costs associated with the building — insurance, maintenance, property taxes — to the tenant through a net lease, most landlords will charge a lower amount of rent.