You might be a seasoned veteran of residential real estate without ever needing to untangle the nuances of a modified gross lease. And there’s a good reason for that. Modified gross leases are typically relegated to the realms of commercial real estate. But can such leases apply in a residential transaction? Short answer: yes. But there’s a heck of a caveat.
What is a Modified Gross Lease?
The modified gross lease is executed in rental agreements, stipulating that the tenant pays a set base rent as well as a share of specific additional expenses divided between the tenant and the landlord. Depending on the lease agreement, these shared expenses can include costs such as:
- Insurance
- Maintenance
- Property tax
- Repairs
- Utilities
A modified gross lease is often regarded as one of the big three lease types, sandwiched between:
- Gross leases – Nearly all property expenses are covered by the landlord.
- Net leases – Most or all of the operating expenses are covered by the tenant.
In commercial real estate, landlords strategically use modified gross leases to give more flexibility to tenant-landlord relationships or keep negotiations moving forward between parties. But what about residential tenants and their landlords? Can this lease type offer similar benefits within the residential framework?
When Might You See Modified Gross Leases in Residential Real Estate?
It’s rare to work a modified gross lease into a residential transaction – but it happens. The most common applications of these leases in residential real estate include:
- Accessory dwelling units (ADUs) on shared property.
- Luxury homes with numerous maintenance demands that tenants may be open to covering or partially covering in exchange for a reduced base rent.
- Multi-family homes in which the utility bill is shared.
The common denominator is a situation in which a landlord and tenant have agreed on a division of responsibilities in addition to a base rent. Sometimes, this is figured as a percentage of a bill. Other times, the tenant agrees to cover specific expenses while the landlord handles others. For example, a tenant may agree to cover the entirety of water, electricity, and trash while the landlord is responsible for landscaping and property taxes.
How This Lease Type Can Benefit Landlords and Tenants
Landlords and tenants each enjoy unique benefits through a modified gross lease arrangement. For a landlord, the flexibility of structuring offered by modified gross leases can open the door to creative solutions otherwise unavailable, allowing them to get the most from their residential investment. This arrangement can also reduce the strain of maintenance bills while attracting tenants looking for a lease tailored to fit their unique needs.
Tenants may be drawn by a modified gross lease’s potential to lower base rents, shifting attention to utility and maintenance costs that are easier to control. They may also want more transparency in cost allocation rather than costs to be simply rolled under a base rent. Either way, this is the kind of lease that can best accommodate this meticulous cost assessment.
Challenges to Modified Gross Leases in Residential Agreements
If you’re considering partaking in a modified gross lease agreement for a residential transaction, you’ll first want to carefully look into local laws regarding this lease type. Location can play a major part in the way expenses are divided in residential real estate, so it’s important to first assess whether a modified gross lease is legal in your municipality.
Once you’re cleared to move forward with the lease, ensure that you are drafting up clear and transparent terms. You don’t want to leave any room for misinterpretation in your lease. Finally, don’t expect every tenant to be familiar or comfortable with a modified gross lease. It’s a highly uncommon lease type in residential real estate, so some tenants may be hesitant or even outright refuse to sign.
Not For Everyone
Obviously, a modified gross lease isn’t everyone’s cup of tea, especially in residential real estate. However, for a landlord looking to simplify costs or a tenant demanding a customized rental agreement, it could be just the creative solution needed. Yet, success is contingent on both parties being well aware of the terms, leaving no room for misunderstanding. Therefore, working with an experienced real estate agent to draft a modified gross lease agreement is all but essential.
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