Full Service Leases Defined and Explained
A full service lease, sometimes known as a full service gross lease, or FSG lease, is a type of commercial real estate lease in which the landlord is responsible for paying all operating expenses for the property. This typically includes insurance, utilities, necessary property repairs and maintenance, taxes, and other, unexpected expenses, but can vary greatly from lease to lease. Depending on the pricing, a full service lease is often the most tenant-friendly type of lease, as it shifts most or all of the expenses to the landlord.
Full service leases stand in contrast to modified gross leases (MG leases), net leases, double net leases (NN leases), triple net leases (NNN leases), and absolute net leases), in which the tenant is respectively required to take on a greater burden of the operating expenses of the property. For instance, in an absolute net lease, a tenant will generally be required to pay all operating expenses, even major ones, such as replacing the roof or paying for major property renovations after a natural disaster. However, the property owner can still benefit from a full service lease, as they can generally charge more upfront than they could if they utilized a net lease structure in the lease agreement.
It should be noted that, since individual lease agreements vary greatly, a lease labeled by one landlord as a full service lease might actually have the same or more operating expenses as a lease labeled as net or double net lease by a different landlord. Therefore, lease type definitions are more of a general guide than a set rule, so it’s essential that both tenants and landlords look carefully over a potential commercial lease before agreeing to anything.
Expense Stops and Full Service Leases
While the concept of a full service lease means that most operating expenses are transferred to the property owner, in reality, this is not always the case. A tenant may be required to pay for one specific expense, such as utilities or insurance. In other cases, a tenant will be required to pay a certain percentage, such as 15 or 30% of all operating expenses.
In this case, an expense stop is often utilized in the lease agreement to protect a tenant from increasing expenses. For example, a tenant could be required to pay 20% of all operating expenses with an expense stop of $25,000 per year. In some cases, a graduate expense stop could be used. For instance, the aforementioned expense stop’s limit could increase by $5,000 per year over the life of a 5-year lease.
Percentage Leases and Per Square Foot (PSF) Lease Pricing
In all of the types of leases mentioned above, any leasing expenses above and beyond the base lease rate are generally charged by a percentage basis, provided that the building has two or more tenants. For example, if a full service lease required a tenant to pay 15% of the operating expenses for the building, and they occupied 30% of the building’s total leasable square footage, they would generally be responsible for paying a 30% share of that 15%. In some cases, different tenants may be responsible for paying different shares of the operating expenses due to individual leasing agreements and addendums.
Both the base rate and the additional expenses are often calculated on a per square foot (PSF) basis. For instance, a one-tenant, 10,000 square foot space with a base annual leasing rate of $25 PSF would have an annual base lease cost of $250,000. If the annual operating expenses for the property were $100,000 and the tenant was required to pay 15% ($15,000) the entire lease (base plus operating costs) PSF price would be $26.50 PSF.
Full Service Lease vs. Modified Gross Lease
As previously mentioned, in a full service lease, or full service gross lease, the property owner is required to pay most or all of the operating expenses of the property. In contrast, a modified gross lease, or MG lease, generally splits up the property operating expenses more evenly among the tenant or landlord. The tenant will often be required to pay one or more of the major operating expenses, such as taxes and utilities, or utilities and insurance, while the landlord may take care of major property repairs or required renovations. In other cases, the operating costs of the property may be split 50/50 or 40/60 between the tenant and the landlord.
Full Service Lease vs. Net Lease and Double Net (NN) Lease
A net lease means that a tenant is required to pay at least one major operating expense for the property, such as taxes or insurance. Net leases often require a tenant to pay more than a modified gross lease, but less than a double or triple net lease, but this depends on the individual leasing agreement. A double net lease is a lease in which the tenant is required to pay for two major operating expenses. During the leasing process, a tenant can often choose which of the two major operating expenses they wish to pay (i.e. taxes and utilities, utilities and insurance, taxes and utilities, or utilities and maintenance).
Full Service Lease vs. Triple Net (NNN) Lease
Under a NNN (triple net) lease, a tenant is generally responsible for paying all property operating expenses, including utilities, maintenance, insurance, and taxes. This means that the base rate of NNN leases are generally less expensive for tenants than net, double net, modified gross leases, or full service gross leases. NNN leases can be ideal for landlords, as their expenses are fixed.
Full Service Leases vs. Absolute Net Lease and Credit Tenant Leases (CTLs)
As previously mentioned, absolute net leases are perhaps the most extreme form of net lease, as they shift nearly all liability to the tenant, even more so than the NNN lease type. However, another type of lease, the credit tenant lease (CTL) lease may be even more extreme, giving the tenant perhaps even more responsibility for the building’s operations. Credit tenant leases are generally only offered to well-established companies, such as national retail brands like Walmart, CVS, Walgreens, Kroger, and the like. Credit tenant leases are often offered on a long-term, 10-20 year+ basis.
Lease Types and Tenant Improvement Allowances
Tenants in any type of commercial lease, including full service gross, modified gross, single, double, and triple net, absolute net, and credit tenant leases may be provided a TI, or tenant improvement allowance, in order to help them change or modify their space to their business’s individual needs. Often, a larger upfront tenant improvement allowance can induce a tenant to agree to a lease type that shifts more of the burden of the operational costs to them vs. the landlord, such as a net lease vs. a gross or modified gross lease.
A reasonably large tenant improvement allowance can be beneficial to both the tenant and the landlord. The tenant gets the money it needs to modify its new space upfront, while the landlord can better estimate future expenses now that more variable operational costs are shifted to the tenant.
Lease Types and Commercial Property Financing
It should be noted that the type of lease a property’s tenants have committed to can have a direct impact on the ability of the property owner to get commercial real estate financing. A lender will generally be far more conservative when underwriting a property with tenants under full service gross leases, as the property owner’s expenses can vary greatly from year to year, which will impact the property’s debt service coverage ratio (DSCR.) If expenses rise unexpectedly, it could impact the owner’s ability to make their mortgage payments.
Therefore, if a property’s tenants are under full service leases, a lender will generally want to see a higher DSCR at the time of loan origination and may wish to underwrite the loan at a lower loan-to-value (LTV) ratio than if the property’s tenants were under a double net or triple net lease, as this would provide the property greater degree of financial stability. Double or triple net lease properties will often be offered higher LTVs and may face lower DSCR requirements than comparative full service lease properties.
On the extreme end, properties with credit tenant leases may be sometimes granted up to 90%-100% LTV loans by lenders due to the incredible strength of the tenant and the extremely low likelihood of tenant default.