Our sponsor partners Feldman Equities recently published an insightful article explaining the difference between Full Service Gross (FSG) and Triple Net (NNN) leases and how these can be used.
Before you can compare the options for leasing office space, it’s important to understand the pros and cons of each. In this article, we’ll look at how FSG and NNN leases work, and the pros and cons of each, to help you decide what type of office lease is right for you and your business.
What is FSG
FSG is an acronym for “full service gross,” which is a type of commercial lease often found in multi-tenant office buildings, and occasionally retail and industrial space. A full service gross lease includes the base rent and other building operating expenses, including janitorial service, utilities, maintenance and repairs, building insurance and property tax, and common area maintenance (CAM). One of the biggest advantages of an FSG lease from the tenant’s perspective is that budgeting the monthly rent expense is easier because there are no variable rent-related expenses such as CAM. This means that if an office suite is leased for $24 per square foot per year FSG and the tenant has a 5,000 square foot office suite, the total monthly rent would be $10,000. Even though a full service gross lease includes everything, experienced office building owners and operators know what the property costs to operate and will factor those expenses in when determining the FSG rental rate. A full service gross office lease may also be written to include an “expense stop” which allows the pass-through to the tenant of any increase in operating expenses above the base year.
Why are FSGs Used? FSG leases are easy for both the tenant and landlord to understand, and can benefit both parties in different ways.
Benefits of an FSG lease In addition to being very straightforward, some of the other main benefits of a full-service gross lease include:
- Total rent charged is higher than the base rent with a NNN lease.
- Opportunity to build expenses – plus an extra margin – into the FSG rent in case costs increase.
- Negotiate an annual rent increase to account for inflation and increased operating expenses.
- Easier for tenants to manage cash flow when the rent expense is the same each month.
- Building services such as janitorial may be less expensive when provided by the landlord than what the tenant can obtain on their own.
Drawbacks to an FSG lease There are also some potential drawbacks to full service gross leases for both landlords and tenants to consider:
- Quoted asking rent per square foot is higher with an FSG lease than with a NNN lease, which could create the perception that the rent of the office suite is more expensive than it really is. For example, the same 5,000 square foot office suite would be quoted at $24 per square foot FSG or $17 per square foot plus NNNs, even though the total monthly rent paid by the tenant might be about the same.
- FSGs leases mean more responsibility for the landlord, with increased involvement in the upkeep of the property.
What is NNN
NNN is an acronym for “triple net,” and is a type of commercial lease frequently found in single-tenant buildings or in multi-tenant buildings where utilities are individually metered. A triple net lease includes only the base rent, with the tenant responsible for paying all other building operating expenses (the NNNs) including property taxes, building insurance, and maintenance (including capital repairs and CAM). This means that if an office suite is leased for a base rent of $17 per square foot per year NNN and the triple net costs are estimated to be $7 per square foot per year and the tenant has a 5,000 square foot office suite, the total monthly rent would be $10,000 ($7,083.33 base rent + $2,916.67 NNNs). When a multi-tenant property is rented using triple net leases, the NNN fees are charged (or passed through) to each tenant on a pro-rata basis. For example, if a 100,000 square foot office building has total NNN operating expenses of $700,000, the NNN expense for the entire building would be $7 per square foot. If a tenant is leasing a 3,000 square foot office suite, the tenant’s pro-rata share of triple net expenses would be $1,750 per month in addition to the monthly base rent.
Why are NNNs Used? Sarasota City Center At first glance it might appear that NNN leases favor the landlord much more than the tenant. However, triple net leases can offer potential benefits to tenants too.
Benefits of a NNN lease: Triple net leases typically run for 5-10 years or more with annual base rent increases tied to the CPI, helping to remove vacancy and inflation risk for the landlord. We know what you’re thinking, how can Multi-family real estate possibly be a good investment opportunity in the midst of the pandemic? Landlords can use NNN leases to shift the overhead or operating expenses of running the office building to the tenant, making the property a good passive income investment Investors often view triple net leases as having bond-like characteristics, because of the consistent income stream generated combined with a reduced level of active landlord involvement in the property. Because tenants with a NNN lease are taking on the landlord’s costs they may also be able to negotiate a lower base rent. Tenants who have a long-term triple net lease can also benefit by having a more permanent office location, which makes NNN leases a good option for regional and national credit tenants.
Drawbacks to a NNN lease Landlords still need to monitor the property to ensure the tenant is performing the required maintenance and upkeep, and make repairs and bill the tenant if the tenant is not upholding the terms of the triple net lease. Although long-term NNN leases do have bond-like characteristics they can also create a cap on earnings for the landlord, if property values in the market increase faster than the annual rent increases agreed to in the NNN lease. A triple net lease can also create an unanticipated financial burden for the tenant if property taxes or other operating expenses are larger than planned, potentially causing the tenant to default on the lease, creating an unexpected vacancy for the landlord.
FSG vs. NNN: What’s the difference?
Here’s a quick look at some of the key differences between an FSG lease and a NNN lease:
Rent A tenant with an FSG lease pays the same amount of rent every month, making budgeting for expenses easier, which is a big benefit for newer businesses. On the other hand, a tenant with a NNN lease pays a lower base rent plus the landlord’s operating expenses.
Maintenance Building repairs, maintenance expenses, and utilities are included in the rent a tenant pays under an FSG lease. A tenant with a triple net lease is responsible for paying the three “nets” of property taxes, building insurance, and CAM in addition to the base rent.
Predictability FSG leases are usually viewed as being more tenant-friendly because they are all inclusive, while NNN leases are more often seen as being more landlord-friendly because operating expenses of the building are passed through to the tenant as additional rent.
Risk A landlord can limit the risk of an FSG lease with an expense stop, which allows operating expenses to be charged to the tenant if they exceed a certain amount per year. While a tenant with a triple net lease faces the risk of fluctuating NNN charges, an experienced landlord may be able to keep operating expenses lower by rebidding vendor contracts or appealing property tax assessments.
FSG vs NNN: Which is right for you?
Castille at Carillon say Tenants looking for predictability are often attracted to FSG leases because the rent is all-inclusive. Paying the same amount of rent every month can be especially attractive to tenants who are growing their business and may not have sufficient monthly cash flow to cover unexpected changes in the rent. On the other hand, the base rent with a NNN lease is lower than the rent with a full service gross lease. This is attractive to tenants with established businesses who are looking for a more permanent office location to lease for the long term. Although operating expenses are passed through to the tenant on a triple net lease, professionally managed and well-maintained office buildings may actually have lower overhead costs for tenants.