Types of leases tenants and landlords need to know

It is essential for the landlords in India to enter into a formal agreement with their tenants before letting out a particular property. This agreement applies more to commercial properties as compared to residential ones. This agreement is given the name of a lease and is of different types like triple net lease, absolute net lease, modified gross lease and full service lease.

What is a lease

Lease is an agreement in which one of the contracting parties, that is the user, decides to pay a specific amount of rent to the owner for the use or occupancy of an asset. The most common type of assets that are leased include commercial buildings, properties and residential apartments.

By virtue of a lease agreement, the lessee obtains the right to use a particular asset or property but the ownership rights vest with the lessor. The lessee also agrees to pay a fair or proportional rent for a specific time in the form of monthly rentals.

The different types of conditions for the use of the property or asset are specified in the lease agreement. Both the parties agree to abide by the various clauses as well as the terms and conditions laid out on the lease agreement.

Types of leases

There are mainly four types of lease that include Triple net lease, Modified gross lease, Full-service lease and Absolute net lease. Other types include financial leases, apartment leases, conveyance type leases, leveraged and non-leveraged leases etc. The four main types of leases are briefly discussed below:

1. Types of leases: Triple net lease

Triple net lease is one of the most common types of lease when we look at commercial properties in India. This type is most preferred by landlords as it forms a highly lucrative stream of revenue generation for house lease. This type of lease agreement requires the tenant to pay some of the additional charges apart from the normal rent and the utility bills like water and electricity charge. These additional charges can include insurance maintenance and upgradation and even property tax.

Due to the high amount of monetary burden on the tenant, this type of lease agreement is mainly restricted to commercial properties that are into profitable business and can easily bear such expenses. This type of lease can be subdivided into three types, that is, single net lease, double net lease and triple net lease.

The first category, that is single net lease requires the tenant to pay only property tax. The second category, that is double net lease would also levy insurance charges on the tenant apart from the property tax. In the third category, that is, triple net lease, property tax and insurance would be compounded by maintenance charges that would be paid by the tenant.

2. Types of leases: Absolute net lease

The second type of lease, that is, absolute net lease, makes the tenant responsible for the structure of the building, in addition to paying the charges that are required in the triple net lease agreement. This means that he would be required to pay the property tax, insurance charges and maintenance charges for the building. Furthermore, he would be responsible for any sort of damage caused to the building structure during the time that he occupies the property. Another name of absolute net lease is bondable lease. This is called so because it makes the landlord free from all financial obligations and puts the entire amount of financial burden on the tenant.

However, the advantage of this agreement is that the corpus of monthly rent is relatively lower as compared to other agreements. This type of lease agreement is usually done when a landlord constructs a customized property taking into consideration the various demands and needs of the tenant. Usually, this type of lease agreement is entered into by businesses and other commercial entities.

3. Types of leases: Modified gross lease

The modified gross lease is different from triple net lease and absolute net lease because the burden of paying taxes, insurance charges as well as maintenance goes to the landlord rather than the tenant. The tenant is required to pay only utility bills. In addition to this, the responsibility of maintenance of the structure of the building also rests with the landlord.

These terms and conditions suggest that the clauses of the modified gross lease agreement are heavily bent towards the tenant as the majority of responsibility is shouldered by the landlord. However, the monthly compensation that needs to be paid to the landlord by the tenant is relatively higher as compared with other types of lease agreements.

This type of agreement is usually followed in different types of areas surrounding business and industrial centers where the population of tenants is relatively higher. As such, a large number of tenants may occupy the same property for residential purposes.

4. Types of leases: Full-service lease

Full service lease or the gross lease agreement is a type of agreement where the owner of the property or the landlord is required to pay various types of taxes, insurance charges as well as maintenance costs. Other types of utility bills like electricity charges, water supply charges, telephone charges and internet charges are usually paid by the tenant depending on the usage. The different types of commercial units that facilitate multiple tenants in the same property usually follow this type of lease agreement.

Advantages and disadvantages of all leases

Various types of advantages and disadvantages associated with leases are listed below:

1. Advantages

  • The biggest advantage of leasing is that it ensures a sustainable source of income for the landlords. For the tenants, the advantage is that they don’t need to pay a one-time payment for buying the property as they can avail the same facilities of the property using monthly rentals.
  • When businesses enter into a lease agreement, it saves them from the huge cost of purchasing a property and they can use this amount to build or invest in other types of quality assets and expand their business.
  • Different types of tax benefits are associated with lease agreements that also allow the tenant as well as businesses to save money that can be invested in other ventures.
  • The best thing associated with a lease agreement is that it remains constant over a lifetime with little fluctuations on account of inflation. This helps in better planning of cash outflows and also guarantees a healthy budgeting exercise.
  • Leasing serves as an essential lifeline for businesses that have been newly established as well as startups that run on low upfront costs and are hesitant to invest in heavy capital infrastructure. Thus, leasing helps such businesses to thrive by means of low capital expenditure.

2. Disadvantages

  • Although continuous rental payments listed out in the lease saves a business from upfront costs, the long term benefits are usually captured by the owner. For instance, it is the tenant who pays lease payments for a land but he gets no benefit of the appreciation in the market price of the piece of land.
  • The process of documentation associated with a lease agreement is usually cumbersome and the clauses spelled out in the agreement are legal and technical, putting it out of common man’s parlance.
  • The ownership rights continue to vest with the owner in spite of the fact that the lessee has made payments and contributed a major share of the asset.
  • The burden for maintenance of the asset usually falls on the lessee although he pays a good sum to the owner. Moreover, various terms in the lease are in favor of the lessor rather than the lessee.

The bottom line

To conclude, lease has its own advantages as well as disadvantages. While it may serve as a prospective option for different individuals and businesses, others may look at it in a negative light. However, the survival and continuation of lease for several years suggests that it caters to a wide group of people who have benefited because of this option.

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