WHAT IS TRIPLE NET LEASE IN COMMERCIAL REAL ESTATE?

A triple net lease also called an NNN lease, is a legal contract between commercial tenants and landlords. Under triple net leases, the tenant pays for the property’s taxes, insurance, and maintenance in addition to the rental rate. The property owner covers structural damage and mortgage payments.

A triple-net (NNN) lease is a contract for commercial property where the tenant is responsible for all expenses related to the property, specifically, property insurance, real estate taxes, and common area maintenance (CAM). In most triple-net (NNN) leases, this also includes all utilities and services used by the tenant. This mainly applies to retail, industrial property, and free-standing buildings.

 

How Does a Triple Net Lease Work

A triple-net lease may sound a bit complicated, but it does not have to. It is very popular with commercial real estate investors all over the country. 

Just like a normal lease, the tenant would agree to pay a monthly rent for the property based mainly on the value of the property. This could be fixed rent for the entire lease term or have a fixed increase at the end of each year to account for inflation.

While the specifics of a triple net lease will vary between properties and agreements, the tenant is typically responsible for paying all expenses required to ensure the full functionality of the building. Triple net leases are common in commercial real estate.

But what are the pros and cons that building owners and tenants accept when signing these common commercial real estate agreements?

 

Pros of Triple Net Leases 

Triple Net properties are very appealing from a commercial investment standpoint due to the many advantages this type of deal can offer to both property owners and tenants. 

• Guaranteed, Long-Term Occupancy:

A NNN lease is structured to offer long-term tenant occupancy (which is often upwards of 20 years), which is beneficial to an investor because it removes the risk and losses of a property sitting vacant between tenants.

 

• Low-Risk Investment:

In a triple net lease, the tenant absorbs all the costs associated with the property, from taxes and insurance to regular upkeep costs.

 

• Reliable Income Stream: 

A Triple Net lease helps secure a reliable income stream from your investment property. Deals are structured to include a consistent amount of rent each month, over an extended period of time, and passing along all the property expenses to the tenant helps protect your investment from unknowns and surprise costs.

 

• Equity:

Many investors add triple-net lease properties to their portfolios as a conservative, low-risk strategy to create more equity. Oftentimes, investors will hang on to a triple net property and use it as an equity builder for at least 5 years, and then sell the property when the market peaks, population spikes, or when they’re ready to use that equity in their next investment.

 

• Little to No Landlord Duties:

With a triple-net lease in place, you’re not tied to the property with your time or money as a landlord. Low-touch management frees up your time for other ventures and ensures you’re not locked into landlord duties for the property.

 

• Lasting Business Location and Footprint:

A long-term NNN lease provides tenants with a great opportunity to create a recognizable and long-lasting location for their business.

 

• Location:

Triple-net lease properties typically offer a great, accessible location for a business. These properties will usually be proximal to other popular businesses, which helps a tenant gain traffic and exposure to customers who frequent other businesses in the area.

 

• Tax Benefits:

In a triple-net lease, the tenant is responsible for property taxes. However, they can build these costs into their business operating expenses to achieve tax benefits for their business

 

Cons of Triple Net Leases

While a Triple Net lease can offer an array of great advantages for both investors and tenants, there are some limitations inherent in these deals that keen investors will want to keep in mind when considering a triple net lease.

• Earning Caps:

While a NNN lease provides a consistent revenue stream each year on your investment, that amount is typically fixed for the term of the lease. This means you can’t increase the rent if property values in your area spike which can limit your earning potential in times of growth.

 

• Vacancy Risks and Rollover Costs:

Though triple net leases are long-term, there is the risk of a tenant defaulting which can result in losses as you try to fill the vacancy. While you can limit this risk by vetting tenants and their businesses thoroughly, this is always an inherent risk.

 

• Assuming Property Expenses:

In a triple net lease, the tenant will be responsible for the majority of the expenses that go into the operation and upkeep of their business location. Tenants must have a strong credit profile to gain an NNN lease, but they should also be prepared to finance the expenses of building operations, in addition to the other expenses that go into running their particular business.

 

• Tax Liabilities:

Because the tenant is responsible for annual property taxes in a triple net lease, this also means that they will be prone to all the liabilities of taxes as well, including fines and penalties for late or incorrect tax remittance.

 

 

 

Calculating a Triple Net Lease

Triple net leases are calculated by adding the yearly taxes on the property and the insurance for the space together and dividing that amount by the building’s total rental square footage. The process of calculating a triple net lease is simplified when an entire building is leased to one tenant.

 

Why should anyone invest in Triple Net Lease?

 As aforementioned at the beginning of this article, triple-net leased properties are becoming more popular among commercial real estate investors because they present relatively low risk compared to other available options and in many cases higher yields. They offer a steady flow of income guaranteed by long-term contracts. They are also very hands-off when it comes to management and expenses because the tenant takes on most of those expenses directly.

 

Who are typical Triple Net Lease Tenants?

The most typical net lease tenants tend to be businesses that offer fundamental services and goods. A few of these types of businesses are grocery stores, restaurants, convenience stores, gas stations, discount stores, and medical companies. If real estate investors find this combination, a net lease property with a “recession-proof” tenant, it is a very advantageous investment opportunity. A steady residual income flow with mitigated chances of failure.

 

CONCLUSION

Triple net leases are common in commercial real estate and come with unique advantages and disadvantages to both building owners and prospective tenants. While we’ve discussed some common advantages and disadvantages to the triple net lease, others may exist including insurance considerations. It’s best to consult with a qualified insurance agent to ensure any property is adequately protected for your individual situation.

 

As informed investors we should understand the risks associated with real estate investing and that there is no guarantee. Please do your due diligence.