A triple net lease is the common lease structure used primarily in commercial real estate. Even though the triple net (NNN) lease is popular, many professionals misunderstand it. Therefore, it's crucial to learn what a triple net lease is, how it works, and what it includes/doesn't include. That way, you can dispel the misconceptions. At the end, you also see a clear example.
What Are Triple Net Leases?
What's a triple net lease? The triple net (NNN) lease is a lease agreement structure where the tenant pays all of the operating expenses for the property. Therefore, they handle building insurance, property insurance, and real estate taxes on top of paying rent. With that, they deal with the maintenance costs for the property.
Overall, this is considered to be a turnkey investment because the landlord isn't responsible for the property taxes, insurance, or operating expenses. That said, you must realize that there are various commercial real estate leases out there, including the single net lease. With that option, the tenant must pay property taxes and rent only.
The Spectrum of Commercial Real Estate Leases (Gross Lease, Absolute Net, Etc.)
Every commercial real estate lease falls along the spectrum, with an absolute net lease at one end and an absolute gross lease on the other. Most of them are somewhere in the middle and are called a hybrid lease.
A triple net lease is often thought of as an absolute version. Just because it's labeled as a triple lease doesn't mean it contains it all. Sometimes, it's just called that for convenience.
For example, when a building is new, the tenant might be responsible for handling replacements. On older buildings, it could be called a triple net, but the landlord must deal with those expenditures.
Sometimes, people think of a triple net as a double net lease, which requires the tenant to pay for property taxes, insurance (including building insurance), and the base rent.
The most important thing here is to read the lease. Make sure that tenants do that to understand the terms. Simple labels aren't enough here.
What an NNN Lease Doesn't Include
Even if the lease is an absolute net lease, it doesn't cover every single expense associated with the commercial property. Though a true absolute net lease with a good tenant is considered a turnkey property from the investor's or landlord's perspective, they do contain expenses that the tenants aren't responsible for.
For example, it's quite rare for the NNN lease to cover accounting costs charged by a landlord's CPA or any legal fees. While they are small in comparison to the purchase price, they aren't part of the monthly cost a tenant must pay in the NNN lease.
Investment Risks with a Triple Net Lease
One common misconception for triple net lease investments is that they're risk-free. Though they offer several advantages, there are risks that must be considered. The primary benefit of triple net leases is that you have a predicted revenue stream for the long-term with pass-throughs in place. Overall, there's less hassle and low management requirements.
Though they are compelling benefits, a triple net lease isn't risk-free. Because most of these investments are for single properties, the tenant credit risk must be understood. For example, you may not doubt a lease guaranteed by a parent company because it's financially strong and publicly traded. However, the tenant could fall out of favor and go bankrupt because nothing is perfect. Since a single-tenant property is fully vacant or not, you should consider this.
Another consideration is re-leasing. Many triple net properties are sold at the end of the long-term lease, which shifts the risk for re-leasing to the new owner. There could be an issue with tenant rollover if they don't have a strong team to handle it.
Assessing Tenant Credit Risk
One crucial component to focus on when analyzing your triple net lease investment property is to understand the credit risk of the tenant. Triple net leases are only as strong as the tenant, so it's best to analyze financial statements on the other side of an NNN lease.
Many single-tenant deals involve large, publicly-traded companies. It's easy to pull up their credit ratings. However, private companies take more effort to complete credit analysis. You must still get and analyze the financial statements and trends to understand if this is the right tenant.
Example of an NNN Lease with Property Taxes
Here is a triple net lease example that shows how it's structured. You look at the cash flows for an investment property and see that there are no expense reimbursements from that tenant. Therefore, you assume that they are an absolute gross lease, so the landlord pays the operating expenses for the property. This includes maintenance costs and all the rest.
However, if the tenant pays all the property taxes and operating expenses, things change. With an NNN lease in place, there is more reimbursement income, which cancels out the operating expenses. To be fair, the lease rate is usually lower than the gross lease rate on the same property. Therefore, the bottom line cash flow with a gross lease is often closer to that of a net lease.
What the NNN lease achieves is a shift in responsibility. Therefore, the risk of paying ongoing expenses shifts from being the landlord's responsibility. Now, the tenant is responsible for paying. For example, if the real estate taxes increase one year at a high rate, the landlord's bottom line is still protected with a triple net lease. The tenant must be responsible for the increased expense.
Overall, you must focus on how much the base rental is, which is often figured based on the square foot amounts. Then, you need to look at your capital expenditures, which include taxes, insurance, maintenance, and all the rest. From there, you can determine if the lease amount is fair and a good investment strategy for you.
Many landlords prefer a double net lease, where the tenant is responsible for paying property insurance and maintenance along with the base rental amount.
Are Triple Net Leases a Good Idea?
This type of lease offers benefits to both landlords and tenants. A tenant has freedom with the structure to customize the space. Plus, they are quite flexible. For the landlord, it can be a reliable income source with fewer overhead costs. With that, the landlord has a less active role in managing the property.
Can You Negotiate the NNN Lease?
Almost all of the responsibilities fall to the tenant. Therefore, the base rental can become a negotiating term. The tenant takes on more risk, so they can get a favorable base rental price.
What's a Landlord Responsible for with an NNN Lease?
The landlord could be responsible for the parking lot, roof, and structure maintenance, depending on the terms of the agreement.
Generally, an NNN Lease is called a triple net lease and is a popular structure for commercial real estate. If you own a commercial property, it's crucial to understand the different net leases out there to determine which commercial lease is right for you.
With that, you learned about the misconceptions associated with an NNN lease and should now be able to determine if it is the right choice for you and your properties.