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A triple net lease (also referred to as triple-net or NNN) obligates the tenant to pay a prorated share of the property expenses for the building insurance, real estate taxes, and common area maintenance (CAM) in addition to rent and utilities. The rent for a property with a triple net lease agreement tends to be lower than a single or double-net lease because the tenant assumes responsibility for more of the property expenses.
The most common expenses included in a NNN lease are property taxes, common area maintenance costs, and building insurance. When a need arises for major repairs, those expenses are often rolled into the maintenance costs.
What’s not included would be the items usually covered by the landlord, such as system repairs, roof repairs, parking lot repairs, and other big-ticket items that are not typically maintenance.
Landlords favor triple net commercial leases because this lease structure allows them to pass along expenses for property taxes, building insurance, and CAM to the building’s tenants. The landlord will typically pay for utilities and debt service. Some triple net leases specify that the landlord will pay for costs associated with the roof, parking lot, and any structural issues.
The NNN lease is as close to a passive income source as an investor can reach if they are involved in rental operations. Unless they face a large repair project for which they are responsible per the lease, investors can sit back and collect rent each month.
Investors have low management involvement in this lease structure because the tenant pays most of the expenses and handles the daily operation. The investor needs only to collect monthly rent and pay the utilities to full fill their management duties.
Most triple net leases are given to tenants with a reliable track record. These tenants use the property’s location as part of their brand marketing and rarely compromise their brand. For example, the branding for a national coffee shop chain is the same at every location. They choose premium locations to rent and commit to long-term leases. If a tenant like this signs a NNN lease, the investor can enjoy a high level of assurance they will be reliable tenants.
Most triple net lease agreements are structured to offer long lease terms for tenant occupancy. A leasing term of 10 or more years is beneficial for landlords because it removes the risk and losses of a vacant property between tenants.
Lenders often extend favorable financing terms for investors who sign on strong tenants with a triple net lease. If reliable tenants signed on with triple net commercial leases, investors could finance properties with as little as a 5% down payment. In contrast, commercial property involving a different lease structure may require 20% or more equity.
A triple net lease is transferable to the new owner upon the sale of the property, whether an investor owns all or part of the property. The transferability makes the property more attractive to new investors.
Triple net leased properties may have single or multiple tenants. If there is just one tenant in the property; occupancy and income drop from 100% to 0% when that tenant leaves. As the tenant approaches the end of the lease term, there is a higher risk if a landlord is unsure whether the tenant plans to renew or vacate.
For a property leased to a single occupant with a triple net lease agreement, the property is often configured specifically for their needs. It is not always possible, without significant construction costs, to reconfigure the space for a different type of tenant. For example, a property once leased to a retail clothing store will require additional utility service if the next tenant is a grocery store.
Landlords who use triple net leases give up some control of the building. They have no involvement in the building’s daily operations. Tenants are responsible for the upkeep, and unless they inform the landlord, the landlord is unaware of any maintenance and repair issues.
A triple net lease suits properties close to other businesses, easily accessible by local traffic routes. Tenants look for such locations because they gain foot traffic and exposure from customers visiting other businesses.
When it comes to evaluating a property’s location, Mike Knudsen, founder & managing principal, NNN Properties Group, evaluates the quality of a location in terms of the following value drivers:
The typical term for a triple net lease is 10 to 15 years, with built-in contractual rent escalation; some triple net leases can extend for 20 years or longer. A lease agreement with a prolonged duration is advantageous for landlords because it reduces the risk and losses of a vacant property between tenants.
Since triple net leases typically involve terms from 10-15 years, the landlord needs a rigorous vetting process for any potential tenant. A triple net lease can be used with any tenant. However, some triple net leases involve popular, strong companies, usually on the stock exchange. If the tenant is a publicly traded company, it’s easy for investors to analyze their financials, business ratings, and stock reports.
Vetting a privately held company can be a bit trickier. An investor will need to look at financial statements, credit history, and market trends for the tenant’s business as part of the vetting process to understand a tenant’s potential risk.
Investors and tenants need to document the property’s condition before the tenant takes occupancy. A property in good condition at the time of lease signing favors the tenant. If the building needs work, the landlord gains an advantage since they pass along the cost of future repairs to the tenant under a triple net commercial lease.
For a building in so-so condition, tenants have little incentive to repair the building except to maintain or improve their continued use of the property. If their business does not rely on their location for branding or customer access but merely needs functional space, they may ignore falling ceiling tiles or walls that could use a coat of paint. They don’t have the landlord’s motivation, who would need to keep the property in good condition to attract a quality tenant.
The property debt is the sole responsibility of the investor/landlord, factored into the lease rate.
“Triple net leases are great for investors who want a long-term, low-risk, hands-off real estate investment experience, and they are also great for tenants that seek more flexibility with their use of the property,” says Peter Evering, the Business Development Manager for Utopia Management.
When you consider both the benefits and the risks, as well as the opportunities on offer by using a triple net lease with the right property, it’s clear that this can be very profitable for investors.
