Gross, Modified Gross, or NNN – What Lease Type Should I Use?

TL;DR: Most small bay industrial properties use modified gross or NNN leases. Gross leases simplify tenant billing but expose landlords to expense risk. NNN leases pass all expenses to tenants but add administrative burden. Modified gross offers a middle ground. Your choice depends on market norms, tenant sophistication, and operational capacity.

The Three Lease Structures

Gross Lease (Full Service)

Tenant pays: Base rent only
Landlord pays: All operating expenses (taxes, insurance, maintenance, utilities)

The tenant writes one check. The landlord handles everything else. Simple for tenants, risky for landlords.

Modified Gross Lease

Tenant pays: Base rent + some operating expenses
Landlord pays: Remaining operating expenses

The most flexible structure. Parties negotiate which expenses are included in base rent and which are passed through. Common splits:

• Landlord covers taxes and insurance; tenant covers utilities and janitorial
• Landlord covers structural maintenance; tenant covers everything else
• Base year stop: Landlord covers expenses up to a base year amount; tenant pays increases

Triple Net Lease (NNN)

Tenant pays: Base rent + all operating expenses (taxes, insurance, maintenance)
Landlord pays: Nothing beyond structural/roof (in absolute NNN)

The tenant pays pro-rata share of all property expenses. Most common in industrial and retail. Requires annual CAM reconciliation.

Comparison at a Glance

Which Structure for Small Bay Industrial?

The Case for NNN

Most small bay flex properties use NNN or modified gross leases. Here's why NNN dominates:

1. Expense protection — With 20–100+ tenants, even small expense increases multiply quickly. NNN protects landlord margins.

2. Investor preference — NNN properties trade at lower cap rates because NOI is more predictable. Better for valuation and financing.

3. Industry norm — Industrial tenants expect NNN. It's what they're used to.

4. Aligned incentives — When tenants pay utilities and maintenance, they have incentive to conserve and report issues promptly.

The Case for Modified Gross

Modified gross works well when:

1. Tenant sophistication is low — Small contractors and service businesses may not understand CAM. Simplifying the bill reduces confusion and disputes.

2. Competitive differentiation — In a tight market, offering "all-in" or simplified pricing can attract tenants.

3. Short-term leases — For 12-month leases, full NNN reconciliation may not be worth the administrative overhead.

4. Submetered utilities — If each unit has separate meters, you might include common area expenses in base rent and have tenants pay their own utilities directly.

The Case Against Gross

Pure gross leases are rare in small bay industrial because:

1. Expense volatility — Property taxes, insurance, and utilities can spike. Landlords absorb all the risk.

2. Tenant behavior — No incentive to conserve utilities or take care of the space.

3. Lower valuations — Gross lease NOI is less predictable, leading to higher cap rates and lower property values.

4. Difficult to adjust — Once you're in a gross lease, raising rent to cover expense increases feels like a rent hike to tenants.

Structuring Modified Gross for Small Bay

If you go modified gross, here are common structures:

Base Year Stop

Landlord pays operating expenses at the "base year" level (usually the first year of the lease). Tenant pays any increases above that amount.

Example:

• Base year CAM: $3.00/SF
• Year 2 actual CAM: $3.25/SF
• Tenant pays: $0.25/SF additional

Pros: Simple to explain. Tenant has predictable base cost.
Cons: Requires tracking base year. Can get complicated with renewals.

Expense Categories

Specify which expenses are included vs. passed through:

• Included in base rent: Property taxes, insurance, common area maintenance
• Tenant pays directly: Utilities, janitorial, tenant-specific costs

Pros: Clear allocation. No reconciliation on included items.
Cons: Landlord retains risk on included expenses.

Fixed CAM

Tenant pays a fixed CAM amount that increases annually by a set percentage (e.g., 3%).

Example:

• Year 1 CAM: $2.50/SF
• Year 2 CAM: $2.58/SF (+3%)
• Year 3 CAM: $2.65/SF (+3%)

Pros: Maximum predictability for both parties. No reconciliation.
Cons: If actual expenses exceed estimates, landlord loses. If expenses are lower, tenant overpays.

NNN Best Practices for Small Bay

If you go NNN, set yourself up for success:

Clear Lease Language

Define exactly what's included in CAM and what's excluded. Common exclusions:

• Capital improvements (or require amortization)
• Leasing commissions
• Landlord's income taxes
• Costs covered by insurance

Realistic Estimates

Don't lowball CAM estimates to make your rent look competitive. Large reconciliation bills frustrate tenants and damage relationships.

Regular Communication

Send quarterly expense updates so tenants aren't surprised at year-end.

Efficient Administration

With 50+ tenants, you need systems. Manual spreadsheets don't scale. Consider property management software that handles:

• Pro-rata calculations
• Monthly billing
• Annual reconciliation
• Tenant statements

What Tenants Should Know

Always Ask for a Breakdown

Don't just look at "all-in" rent. Understand:

• Base rent per SF
• Estimated CAM per SF
• What's included vs. excluded
• Historical CAM actuals

Negotiate Caps

Consider requesting:

• CAM caps — Maximum CAM can increase year-over-year (e.g., 5%)
• Gross-up limits — Restrictions on occupancy adjustments
• Audit rights — Ability to review landlord's expense records

Budget for Variability

NNN leases mean your occupancy cost will fluctuate. Budget for 5–10% CAM variance.

The Bottom Line

There's no universally "right" lease structure—it depends on your market, tenant base, and operational capacity.

For most small bay industrial properties:

• NNN is the default for sophisticated tenants and institutional ownership
• Modified gross works well for smaller operators and less sophisticated tenants
• Gross is rarely appropriate due to expense risk

Whatever structure you choose, clarity is key. Tenants who understand their costs are happier tenants. Landlords who protect their NOI build more valuable properties.