Modified Gross Lease

Modified Gross Lease is a lease rental agreement wherein the lessee pays for the basic rent at the start of the lease and pays for the proportionate share of property taxes, insurance premiums, and maintenance expenses during the lease tenure.

A modified gross lease is majorly used in the case of commercial properties where there is more than one tenant to share the property, while also sharing the operating expenses along with the owner. It is different from gross lease arrangement where a tenant is not supposed to pay the operating expenses related to the property.

A modified gross lease is a commercial lease agreement wherein the lessee pays the basic lease rental and shares the operating expenses proportionately with the lessor. This lease agreement is a hybrid mix of triple net lease and gross lease.

In the case of a modified gross lease, to lease out the property, the owner agrees with the lessee where the lessee makes the payment of the basic lease rental for the initial year. During the subsequent years, the lessee continues to make the payment of the basic lease rentals. And along with that, the lessee also makes the payment of operating expenses attributable to common sharing areas in proportion to the occupancy level. Opex includes repairs, maintenance, utilities, and taxes attributable to the common sharing area of the leased property.

Let us consider the following instance to understand the modified gross lease meaning better:

Suppose XYZ Mall is leasing out the commercial property spaces. ABC Inc. expressed its interest in taking one shop commercial in the mall under the modified gross lease agreement. As per the modified gross lease agreement ABC Inc. (the lessee) will pay the US $ 100,000 p.a. as the basic rent to XYZ Mall every year. Apart from the basic lease rentals, ABC Inc. will also pay for the operating expenses (such as repair and maintenance, insurance, utilities, etc.) attributable to the common area proportionate to his occupancy level for subsequent years.

The modified gross lease arrangement is of great importance because of the advantages it offers to the parties involved, especially the tenants. The tenants pay a specific amount and get to enjoy all the facilities that the landlords make available by letting them use their property. Some of the advantages of this arrangement for tenants – the lessee and landlords – the lessors are listed below:

Tenant (Lessee)

The following are the benefits of a modified lease to the tenant.

• The tenant may opt for a modified lease as in the case of the modified lease, and he will only have to bear the proportionate operational expenses. ABC Inc. has taken a shop in a mall on lease with a 20% level of total occupancy of the entire property.
• Now, if in the subsequent year the operational expenses will rise by the US $ 50,000 as compared to the expenses incurred in the base year, even then, the tenant will bear the proportionate increase, that is US $10,000 (the US $ 50,000 x 20%) and not the entire US $ 50,000.
• Also, the tenant will favor the modified lease as the structure of the modified lease ensures that the landlord or the lessor will share an obligation to keep the property a good fit and be involved in the repair and maintenance activities of the property.

Landlord (Lessor)

From the lessor's point of view, the modified lease offers a sense of control over the property as he can keep a check on the tenant to ensure he is managing and maintaining the property reasonably.

Besides multiple benefits that this arrangement of lessor-lesser offers, there are a few limitations of this set up, which also needs to be known to the parties considering this option. Let us have a look at some of these disadvantages for tenants as well as landlords in brief:

Tenant (Lessee)

The following are limitations of a modified lease to the tenant.

• If the landlord fails to maintain the common area as per basic standards, there might be a possibility that such bad maintenance can affect the lessee's business.
• Moreover, the escalation of variable expenses can affect the budget of the lessee. For instance, if electricity consumption increases with the rise in the occupancy level of the property, in that case, the lessee may get overcharged and pay the escalated price.
• One possible solution to avoid such a problem will be to add a gross-up clause in the agreement, which defines and sets the cap limit for the lessee in case of an escalation of the price of variable expenses.

Landlord (Lessor)

The potential limitation of the modified lease to the lessor will be the underestimation of the lease rentals and amount due to operating expenses. The underestimation of expenses may cause operating losses for the lessor. That is why most landlords prefer a triple net lease agreement, as it sets the lessee liable to make the payment of lease rentals and all the operating expenses.

When it comes to leasing a property, there are many options that one may come across. The most common ones, however, include gross lease and NNN or Triple Net Lease besides modified gross lease. To understand how they differ from each other, browsing through the differences may help.

Let us have a comparative look at the three of them below:

• While NNN includes only the base rent of the property in question, the gross lease is the base rent plus operating expenses involved in the property. On the contrary, the modified gross lease has properties of both of them.
• Gross lease is applicable for various real estate properties, but it is most evident in office buildings. On the other hand, NNN is evident in retail and industrial units, while modified gross lease applies to lesser property as this arrangement is the least common of all.
• The gross lease puts all liabilities on the property owner, while NNN holds tenants responsible for the risks. On the other hand, modified gross lease is a safer option, which helps landlords and tenants have a middle ground to reach a mutually agreed upon conclusion.

This article has been a guide to what is Modified Gross Lease. Here, we compare it with Triple Net Lease or NNN, and explain its examples, benefits, and limitations. You can learn more about finance from the following articles –

• Sublease
• Leaseback Definition
• Leasehold Definition
• Equipment Lease