What Is a Gross Lease? Full, Modified and Industrial Gross Under ASC 842
A gross lease is a lease in which the tenant pays one fixed rent and the landlord pays the building's operating costs out of it. Property taxes, building insurance and common area maintenance (CAM) are the landlord's problem. The tenant writes one check, and the amount does not move when the tax bill does.
Under ASC 842, that single fixed rent is a lease payment under ASC 842-10-30-5. If the lessee has elected the ASC 842-10-15-37 expedient, all of it goes into the lease liability. Without the election, the share allocated to services such as CAM is excluded (ASC 842-10-30-6(c)).
Modified gross and industrial gross leases move some costs back to the tenant. Costs the tenant pays the landlord on actual bills are usually variable lease payments, which stay out of the liability (ASC 842-10-30-6(a)).
Costs that are the tenant's own, such as electricity it buys from the utility on its own account, sit outside lease accounting altogether. The KPMG Handbook: Leases (paragraph 4.2.150) says this of taxes and insurance that are the lessee's own costs. A landlord cost the tenant pays directly to a third party stays in lease accounting (ASC 842-10-15-30(b)).
What does a gross lease cover in the contract?
The gross lease meaning is about who carries the operating costs, not about the size of the rent. In a full gross lease, sometimes called a full service lease, the landlord pays three groups of cost and recovers them through rent:
- Owner's costs. Real estate taxes and the landlord's property insurance.
- Shared services. CAM, such as cleaning, landscaping, lighting and parking lot upkeep.
- Often, building services. Utilities and janitorial work inside the suite, in many office leases.
The landlord prices all of that into the rent and keeps the risk that costs rise. For the net side of the market, including single, double and triple net, see our page on triple net lease meaning and NNN rent.
"Gross," "modified gross" and "industrial gross" are market terms. Topic 842 does not define any of them. The accounting follows what each clause requires the tenant to pay, and whether that amount is fixed or variable.
What is a modified gross lease?
A modified gross lease, often shortened to MG lease, splits operating costs between landlord and tenant. There is no standard split. The lease names which costs pass through, and the split varies by market and by building.
Two patterns show up often in office and flex space:
- Base-year stop. The landlord pays operating costs up to the level of a named base year. The tenant pays its pro rata share of any increase above that level.
- Direct-pay carve-outs. The tenant pays its own electricity and suite janitorial directly. The landlord keeps taxes, insurance and CAM inside the rent.
Some modified gross leases do both. The operating expense clause, not the label, decides.
What is an industrial gross lease?
An industrial gross lease is the warehouse and light industrial version of a modified gross lease. Usage varies, but a common form has the landlord pay real estate taxes, building insurance and structural repairs. The tenant pays its own utilities, interior maintenance and sometimes trash or HVAC service.
Some industrial gross leases also pass through tax and insurance increases over a base year. As with modified gross, the term has no fixed meaning. The clauses decide the accounting.
Is all of a gross lease's rent a lease payment?
Usually yes, once you know what the rent pays for. The landlord's taxes and insurance built into gross rent stay in the lease payments. Only a service such as CAM can be split out.
The rule starts with the components of the contract. ASC 842-10-15-30 says components include only items that transfer a good or service to the lessee. Paragraph 842-10-15-30(b) then excludes the "reimbursement or payment of the lessor's costs," such as taxes and insurance. Paying them "does not transfer a good or service to the lessee separate from the right to use the underlying asset."
So the landlord's taxes and insurance are never a separate component. In a gross lease, though, the tenant still pays for them through fixed rent. That fixed amount stays in the consideration in the contract.
Deloitte says the same about taxes. Its Roadmap: Leases, section 4.3 covers property taxes "included in the consideration in the contract (i.e., the costs are fixed in the contract)." Those taxes, it says, "are allocated to the separate lease and nonlease components."
On the books, the tax and insurance piece of gross rent is not carved out and expensed. It rides along with the space. If the contract has no services in it, the full fixed rent is the lease payment.
Under ASC 840 these executory costs were excluded from the lease measurement. Under ASC 842, fixed payments of the landlord's taxes and insurance are part of the consideration in the contract (KPMG Handbook: Leases, paragraphs 4.2.230 to 4.2.240).
The KPMG Handbook: Leases (Question 4.2.50) draws the balance sheet conclusion: "Lessees will generally recognize smaller ROU assets and lease liabilities for a net lease than for a gross lease." ROU means right-of-use. The net tenant's tax and insurance payments are variable, so they are left out. KPMG's Example 4.2.20 sets a gross and a net version of the same building side by side.
What changes when the landlord's CAM sits inside gross rent?
CAM is different. The landlord performs a service the tenant would otherwise buy, so CAM is a nonlease component. Example 12 in ASC 842-10-55-144 to 55-145 reaches that conclusion for common area maintenance. When CAM is bundled into a fixed gross rent, part of that rent pays for a service rather than for the space.
A lessee that separates components allocates the fixed consideration between them. Under ASC 842-10-15-33, it determines the relative standalone price of the lease and nonlease components, then allocates "on a relative standalone price basis." Only the share allocated to the lease component goes into the lease liability. The CAM share is expensed as the service is received.
Many real estate lessees skip that step. ASC 842-10-15-37 lets a lessee, "as an accounting policy election by class of underlying asset," choose not to separate nonlease components. Each lease component and its associated nonlease components are then accounted for as a single lease component.
How do full, modified and industrial gross compare on the same space?
Take one 10,000-square-foot space leased three different ways. Every input below is stated so the arithmetic can be checked. The structures are illustrative.
- Term: 5 years, annual rent paid in arrears, no renewal or purchase option.
- Discount rate: 6%. The five-year annuity factor is 4.212364.
- Classification: operating lease. No initial direct costs, incentives or prepaid rent, so the ROU asset equals the lease liability at commencement.
- Policy: the tenant has elected the ASC 842-10-15-37 expedient for real estate, except in the last row.
- Full gross: $120,000 fixed rent per year. The landlord pays taxes, insurance and CAM.
- Modified gross: $110,000 fixed rent per year. The tenant pays its own electricity and janitorial, $6,000 in year one. It also pays its share of tax and insurance increases over a year-one base year: $0 in year one and an assumed $4,000 in year two.
- Industrial gross: $108,000 fixed rent per year. The tenant pays its own utilities and interior maintenance, $12,000 in year one.
- Full gross, CAM separated: the full gross lease without the expedient. Assumed standalone prices are $114,000 for the space and $9,000 for CAM, per year.
| Structure | Annual payment | Liability and ROU asset | Year 1 lease cost | Year 1 other cost | Year 1 total |
|---|---|---|---|---|---|
| Full gross | $120,000 | $505,484 | $120,000 | $0 | $120,000 |
| Modified gross | $110,000 | $463,360 | $110,000 | $6,000 | $116,000 |
| Industrial gross | $108,000 | $454,935 | $108,000 | $12,000 | $120,000 |
| Full gross, CAM separated | $111,220 | $468,497 | $111,220 | $8,780 (CAM) | $120,000 |
How the figures are built: ASC 842-20-30-1 measures the lease liability at the present value of the lease payments not yet paid. Here, that is the annual lease payment times 4.212364, which is (1 − 1.06−5) ÷ 0.06. Because rent is flat, the straight-line lease cost equals the annual payment.
In the last row, the lease share is $114,000 ÷ $123,000 × $120,000 = $111,219.51 a year. It is shown rounded to $111,220; the liability uses the unrounded $111,219.51. CAM takes the remaining $8,780.
The modified gross tenant has no variable lease cost in year one, the base year. Its total is $116,000, not $120,000, because the three structures are priced independently. They are not set to equal the same cash cost.
The full gross and industrial gross tenants both spend $120,000 in year one. The full gross tenant books $50,549 more lease liability, because more of its cost is fixed rent. Separating CAM moves $36,987 of the full gross liability off the balance sheet without changing the cash.
The triple net lease page runs a different space: $156,000 gross rent against $120,000 NNN base rent, with the same effect on the balance sheet.
The direct-pay costs in the modified and industrial gross rows are the tenant's own costs. It buys the electricity and the suite cleaning from its own vendors, and the landlord provides neither. They are ordinary period expenses outside the lease liability. The KPMG Handbook: Leases (paragraph 4.2.150) takes the same view of taxes and insurance that are the lessee's own costs.
A landlord cost is different. It stays in the tenant's lease accounting even when the tenant pays the third party directly (ASC 842-10-15-30(b); KPMG Handbook: Leases, Question 4.2.40). And when the landlord itself provides the utilities, they are a nonlease component, as Deloitte's section 4.3 and KPMG's Question 4.2.20 explain.
How are base-year pass-throughs recorded after commencement?
The base-year stop in a modified gross lease creates variable payments. At commencement nobody knows whether taxes and insurance will rise, so the tenant's share is not fixed or in substance fixed. It is left out of the lease payments under ASC 842-10-30-5 and 30-6(a).
The tenant records the year-two increase in the period the obligation for it is incurred, under ASC 842-20-25-6(b). For an operating lease, that paragraph recognizes "variable lease payments not included in the lease liability in the period in which the obligation for those payments is incurred." In the example, the assumed $4,000 is year-two variable lease cost. The liability is not touched.
If the lease fixes the pass-through instead, say a flat $4,000 a year from year two, the amount is fixed and belongs in the liability. The same holds for a lease that fixes the expense share, or sets a minimum the tenant must pay. That fixed amount or minimum is in substance fixed (ASC 842-10-55-31).
The test is whether the amount is, in effect, unavoidable, as the PwC, Leases guide, section 3.3.4.3 explains. Pass-throughs are a common source of hidden lease costs.
Scheduled escalations in gross rent are still fixed rent. For an operating lease, the liability tracks the present value of the remaining payments. The straight-line difference adjusts the ROU asset (ASC 842-20-35-3(a) and (b)), as our accrued rent accounting example shows.
Frequently asked questions
Does a gross lease put more on the balance sheet than a net lease?
Usually, for the same total occupancy cost. In a gross lease the landlord's taxes and insurance are built into fixed rent, and fixed rent is a lease payment that goes into the liability. In a net lease the tenant pays those costs on actual bills, which are variable and stay out of the liability.
Are base-year increases in a modified gross lease part of the lease liability?
No, when they depend on actual costs. The tenant's share of increases over the base year is unknown at commencement, so it is a variable payment. It is expensed in the period the obligation is incurred under ASC 842-20-25-6(b) for an operating lease and never enters the liability.
What does a gross lease mean for the tenant?
It means one fixed rent that already covers the landlord's taxes, insurance and usually CAM. On the tenant's books, that fixed rent is a lease payment, so it goes into the lease liability at present value instead of running through variable expense. Without the ASC 842-10-15-37 expedient, the CAM share is carved out.
Sources and further reading
- Deloitte, Roadmap: Leases, section 4.3, Identify the Separate Nonlease Components: ASC 842-10-15-30 and 15-37, Example 12 on CAM, landlord utilities and fixed taxes.
- PwC, Leases guide, section 2.4, Separating lease and nonlease components: ASC 842-10-15-33 allocation of the consideration in the contract.
- PwC, Leases guide, section 3.3.4.3, Variable lease payments: in substance fixed payments and minimums.
- Deloitte, Roadmap: Leases, section 8.4, Recognition and Measurement: ASC 842-20-25-6 and 842-20-30-1.
- KPMG Handbook: Leases: Question 4.2.20 on utilities, Question 4.2.50 and Example 4.2.20 on gross and net leases, and paragraphs 4.2.150, 4.2.230 and 4.2.240 and Question 4.2.40 on lessee and lessor costs.
- FASB ASC 842-10-15-30, 15-33 and 15-37; 842-10-30-5 and 30-6; 842-10-55-31 and 55-144 to 55-145; 842-20-25-6, 30-1 and 35-3.
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