Students of economics are familiar with the acronym "TANSTAAFL," which stands for "there ain't no such thing as a free lunch." This rule also applies to commercial leases. Although a lease term may or may not include a provision for direct reimbursement of property taxes, the owner's return is based on what they collect in rent, reduced by what he spends in expenses.
Real Estate Income
The owner of a piece of property has the ultimate responsibility for paying property taxes. The way that investment property works is that an owner invests a certain sum of money to buy a property with the expectation of collecting rent and other income. The owner then takes that money and uses it to pay the property's operating expenses, insurance costs and property taxes. With what is left over, known as the property's net operating income, he then makes mortgage payments, invests some back into the property and hopefully pockets some profit. An owner will typically only buy a building if there is profit to be made, meaning that the tenants' payments need to cover all of the expenses.
Triple Net Leases
One of the most popular lease structures for a commercial property is the triple net lease. This means that the tenant pays rent and also pays all of the expenses of operating the building. In most cases, the owner collects each tenant's relative share of the expenses, and uses the tenant's money to pay the bills. In some cases, such as properties with only one tenant, all of the bills are directly sent to the tenant to pay, leaving the landlord just to collect the rent check. In these instances, the tenants directly pay the property taxes.
Full Service Leases
A full service lease is where the tenants make a single flat payment to the landlord, and the landlord pays all of the expenses of the building. Although it may seem that, in this instance, the landlord is paying the property taxes, the situation is actually more complicated. This is because, in most cases, the full service rent rate is significantly higher than the rate for a triple-net lease. As an example, in a market where operating expenses are $11.00 per square foot, tenants may be offered a rent of $30.00 on a full service basis, or a rent of $19.00 on a triple-net basis with additional expense liability of $11.00. In either case, the tenant spends $30.00 per foot and his money pays for the property taxes.
In addition to the initial base rate, many leases have escalators that make the rate periodically increase. In the case of a triple net lease, the escalator is essentially pure profit for the owner, since the expense reimbursements fluctuate with the building's expenses, allowing them to go up as property taxes increase. With a full service lease, the escalator applies to the entire rental payment, letting the owner keep what is left after he has used the increased rent to pay out any expenses that have gone up.