The effect of commercial lease
structures on landlord-tenant
leasing behaviours and experiences
(Gross lease vs. net lease)
Dulani Halvitigala, Deborah Levy, Laurence Murphy
The University of Auckland
New Zealand
Commercial property lease structures
 Commercial leases
 Should be responsive to the requirements of both landlords & tenants (Jaffe and
Yang, 1997)
 Landlords’ and tenants’ different lease objectives can cause tension in the
operation of leases (Crosby et al., 2006)
 Landlords attempt to enforce strongly pro-landlord lease forms by being inflexible
towards tenant requirements (Crosby et al., 2006; Crosby et al., 2003; Dunn, 2003; Lizieri et al.,
1997; Saltz, 1990)
 Importance of in-depth understanding of commercial leases
 Diversity of lease structures in the market (Parker and Robinson, 2000)
 Different leases shift the risks and opportunities between the landlord & tenant
(Rowland, 2000)
Related commercial leasing literature
 Largely focused on financial characteristics of leases and the effect of various
lease covenants on investment returns (Adair et al., 1994; Hamilton et al., 2006; Turner and
Thomas, 2001a, Turner and Thomas, 2001b)
 Evaluation of alternative lease structures are dominated by financial-qualitative
aspects of leases (Metawa, 1995)
 Behaviour of market participants determines the nature of property market
operations (Daly et al., 2003; Diaz III, 2000; Diaz III, 1999; Hardin III, 1999; Levy and Henry, 2003)
 The application of behavioural interpretations in property literature is limited to
property valuation issues (Leishman and Watkins, 2004; Roberts and Henneberry, 2007)
 Little attention is given to understanding the impact of different lease forms on
the behaviours and experiences of key market agents in leasing
Purpose of study
Research questions
Research aim

Do landlords and tenants have different
perceptions of gross & net lease

structures?
Examine the effect of

different lease
and experiences of landlords and tenants
structures on landlordtenant behaviours and
under gross & net leases?

experiences (Gross
versus net leases)
Are there any differences in the behaviours
What are the key issues confronting them
under gross & net leases?

Do lease structures have any impact on the
financial and non-financial characteristics of
leases?
Research focus
 Significant leasing environment in New Zealand
 Auckland (commercial capital) – mainly net, private sector dominated
 Wellington (political capital) – mainly gross, public sector dominated (41%)
 Lease structures examined
 Gross lease – landlord pays directly for OPEX without separate charge to the tenant
 Net lease – tenant to pay all or portion of the landlord’s property expenses
 Property sector examined
 Prime office sector in New Zealand
 Study sample
 Landlords – New Zealand’s listed property trust sector
 Tenants – Major tenants of the properties owned by NZLPTs (in Auckland &
Wellington)
Research methodology – Landlords

Survey sample – NZ Listed Property Trusts

Total portfolio value – NZ$7.377 billion, Market capitalization – NZ$3.6 billion

Data collection method – in-depth interviews

Interview participants – 6 portfolio managers attached to the top 3 NZLPTs
Interviewee
1
Value of the portfolio
managed ($m)
Total NLA
managed (m2)
Type of office
properties owned
2
Job Title
National Commercial Portfolio
Manager
Wellington Portfolio Manager
3
Auckland Portfolio Manager
751.50
106,889
Prime
4
General Manager
390.00
117,810
Prime + Secondary
5
National Asset Manager
540.44
144,028
Prime + Secondary
6
Asset Manager
650.13
190,598
Mainly Prime
856.17
170,968
Prime quality
817.45
146,046
Prime
Research methodology – Major tenants
Tenant survey – Major tenants of LPTs
Data Collection
236 surveys sent
Auckland – 137
Wellington - 99
Response rate
Nature of tenants
Data analysis
65 returned
Pubic – 23
International – 19
NZ national – 23
Statistical analysis
Overall – 38%
Semi-structured, in-depth interviews
Data Collection
4 public sector tenants
4 private sector tenants
Participant profiles
Output
National property manager – 1
General manager (property & operations) – 2
Director, corporate services – 2
Senior property managers – 3
Probe and explore
the survey findings
in more depth
Conclusion – Integration of the findings of the two approaches
Findings - Tenant perceptions of leases
 Significantly varied with their business sector
Public sector tenants
Private sector tenants
 Preferred lease type – gross lease
 Preferred lease type – net lease
 Current lease types – mainly gross
 Current lease types – mainly net, some gross
even in Auckland
 Priority – certainty in the TOC.
Financially constrained by
budgetary requirements
 Strong negotiation power
 Act together under the direction of
State Services Commission & the
Treasury in leasing activities
leases in Wellington
 Changes in attitudes – in favour of net lease due
to bad experience with gross lease
 Priority – quality of the premises than the TOC
 International tenants are more resistant to gross
leases than NZ tenants
 Familiarity with net leases overseas
Reasons for tenants’ lease preferences
Public tenants – gross lease
Private tenants – net lease
 Simplicity
 More responsive and proactive landlords
as the costs can be recovered
 Certainty of the total occupancy
costs
 Risks of OPEX increases are
landlords’
 Property management is the
landlord’s responsibility
 Gives more time to concentrate on
their own businesses
 Applies more discipline to landlords
towards OPEX
 Landlord can change the management
style or the OPEX to meet tenant
requirements
 Easier to maintain the premises to the
standard tenants desire
 Better maintained and better quality
accommodation
 More tenant involvement with the
management of the property
Landlord perception of leases

Preferred lease type – fully recoverable net leases



Greater security of the NOI and asset residual value, reduced investment risks
Strong objections to gross leases

NOI is prone to OPEX price inflations

Do not have freedom in raising gross rentals due to market competitiveness
Current leases in their portfolios

Auckland – net leases

Wellington – mainly gross leases due to the strong influence of public sector tenants
 Despite the strong preference for fully recoverable net leases, their
leasing strategies and behaviours significantly varied across submarkets
in New Zealand with the sector and size of the tenant
Financial implication for investment returns

Gross leases are at high risk of receiving lower & more volatile net return
 Unable to share or shift the risks associated with OPEX

Small landlords operating in isolation experience more negative impact
 Low negotiation power, Ill-negotiated lease provisions
 Poorly planned lease and OPEX management philosophies

The impact on NOI is minimal for large scale institutional landlords
 Strong OPEX purchasing power
 Long term fixed contracts with service providers
 Carefully prepared OPEX budgets
 Short rent review intervals
“Large property funds operate both gross and net leases in a similar way, so that puts away a lot
of arguments about pros and cons of net & gross. But for small, less sophisticated landlords with
poor OPEX purchasing power, gross leased buildings will definitely be a poorer performer”
OPEX sharing process
Landlord’s perspective
Tenant’s perspective
 Attempt to negotiate “gross plus
 Public sector tenants
increases” leases with public tenants
 Do not wish to pay any OPEX
 Maintaining the property is landlords’
 Recover almost all OPEX from net
core business, not tenants’
lease tenants
 Pass-through some expenses which
have been identified as non-
 Private sector tenants
 Willing to share OPEX to have a well-
maintained property
passable in the literature
 Sinking fund contributions,
management fees, corporate fees
 Reflect their strong negotiation power
 Unhappy that landlords retain the full
control of OPEX management decisions
 Want to have more control over the
OPEX they are paying for
Issues with OPEX sharing process under
net lease
Landlord’s perspective
Tenant’s perspective
 Perceive that there are no
significant issues with the OPEX
sharing process
 Net tenants are more dissatisfied with their
OPEX responsibilities than landlords
perceive they are
 Overcharging
 Tenant queries mainly on:
 Invoiced for items not legitimately considered as
OPEX
 Power expenses
 Less transparency in OPEX calculations
 Repair type work
 Delays in OPEX reconciliations
 Sinking fund contributions
 Slow response to OPEX queries
“Every now and then we’ll have something
someone wants to clarify. No, we don’t
usually have problems, in OPEX wash-up
time we might get 3 or 4 enquiries, but
nothing of any real consequences”
 Larger tenants have less issues
 Receive all proposed OPEX and CAPEX
budgets in advance
 Opportunity to discuss and debate proposed
budgets
Operation & maintenance process
Landlord’s perspective
Tenant’s perspective

Element of under-maintenance of
gross leased properties


More evident in early stages of
gross leases


More evident with short-term
investors
Less evident in gross properties
owned by institutional investors


Reporting requirements to their
shareholders
Desire to maintain the reputation of
their company and its buildings
Gross tenants are more satisfied with their
buildings’ O&M process than net tenants
 Net tenants have higher expectations as they
are paying for O&M
 Net international tenants compare O&M
levels with their buildings overseas
 Public tenants are more satisfied with their
buildings’ O&M process than private tenants
 Different expectations of public and private
sector tenants
 Strong influence enjoyed by public tenants
 Private sector tenants may have more skills
in early detection of O&M inefficiencies
Landlord-tenant relationship
Landlord’s perspective

Adopt different relationship
approaches with different
tenants

Partial and biased towards more
desirable tenants despite their
lease type

Tenant’s perspective

Gross tenants perceive stronger
relationships with their landlords than net
tenants

Simplicity in gross leases

More potential for conflicts under net
leasing
Partnership-type relationships

with major tenants

Adversarial-type relationship with
small tenants

Conflicts over the OPEX, more suspicious of
landlord’s OPEX spending
Conflicting attitudes expressed by
international tenants

Landlords’ aversion to gross lease has a
negative impact on relationship levels
Future lease preferences
 Possible mismatches between tenant lease requirements and actual leases
offered in the future
Landlord’s perspective
Tenant’s perspective
 Net leases with 100% recoverable
 Public sector tenants
OPEX
 Preference to maintain gross leases
 More flexible leasing approach in
Wellington
 Tougher lease provisions
 More expenses items as OPEX passed
through on to tenants
 Private sector tenants
 Prefer net leases with measures to reduce
uncertainty in OPEX
 Capped OPEX
 Annual rent reviews
 CPI adjusted OPEX increases
 Obligations on tenants in terms of
 Recover only increases in OPEX
environmental sustainability
Flexibility in tenant future lease selections
Public sector tenants
Private sector tenants
 Willing to consider net leases if:
 International tenants
 the building is green or new, energy
efficient
 Strongly resistant to gross
 Wouldn’t accept gross even offered
 they are the sole tenant or have the
naming right
 the terms and conditions of the net
lease are in favour of the tenant
 they are satisfied that the landlord is
competent, trustworthy, and substantial
 National tenants
 More flexible
 Willing to consider gross as an
option, but would be cautious
Discussion and implications
 Different lease structures have significant implications for financial outcomes
(net returns) as well as non-financial outcomes of leases
 Distinctive perceptions, leasing behaviours and experiences of landlords
and tenants under different lease environments
 Despite landlords’ strong preference for fully recoverable net leases, they
adopt more flexible leasing strategies with more desirable and more
influential tenants in their portfolios

Power asymmetry could work in favour of either landlord or tenant depending on size
and influence

Balance of power between landlord & tenant determines the nature of lease operation
Discussion and implications

Major differences between the perceptions, behaviours and experiences
of private and public sector tenants, as well as international and national
corporate tenants

Gaps between tenants’ lease requirements and those currently offered
by landlords

Importance of understanding the dynamics of key market agents that
create lease environments and how these agents interact and behave
within these contexts