RESOURCES - TRIPLE NET LEASE
If you are interested in commercial real estate investments, it is likely that you have come across the terms “net lease” and “triple net” lease. However, it is important to note that these terms can have varying meanings depending on the context and market. The misuse of these terms in real estate can be confusing for potential investors.
It is worth noting that while the term “net lease” technically refers to the type of lease and not the property type, it is commonly used to describe single-tenant properties that are leased on a “triple net” or “NNN” basis. In this type of lease, the tenant is responsible for all property operating expenses. While triple net lease investments can apply to various property types, they are most found in retail, industrial, and office properties.
It is important to understand the various types of leases in commercial real estate, as each type can differ in terms of who is responsible for specific property operating expenses. As an investor, it is crucial to note that investment risk and landlord responsibilities increase as the number of “nets” decreases.
The different types of leases include full service or gross leases, single-net or “N” leases, double-net or “NN” leases, triple-net or “NNN” leases, and absolute or bondable leases. In a full service or gross lease, the tenant pays a negotiated sum for rent, while the landlord is responsible for all property expenses. In a single-net or “N” lease, the tenant pays monthly rent plus property taxes, while the landlord is responsible for all other expenses. In a double-net or “NN” lease, the tenant is responsible for paying monthly rent, property taxes, and property insurance, while the landlord is responsible for all other operating expenses. In a triple-net or “NNN” lease, the tenant is responsible for property taxes, property insurance, and operating expenses, in addition to monthly rent. The landlord remains responsible for capital items related to the building’s structural components, such as roof replacements. Finally, an absolute or bondable lease places all responsibilities on the tenant, including “roof and structure” responsibilities, regardless of circumstance. This type of lease is typically only found in standalone single-tenant buildings with national tenants, often with investment-grade credit ratings, and is described as a corporate bond backed by commercial real estate.
When considering investing in real estate, it is crucial for investors to carefully review the specific lease terms regardless of the lease type terminology used to describe a property. Net lease properties, in particular, are a popular choice for investors seeking passive real estate investments with long-term, stable cash flow.
Triple Net-Lease (NNN) refers to a property that is 100 percent leased to one tenant, with a lease structure in which the tenant is responsible for all property-related expenses, leaving the landlord with minimal responsibilities. NNN properties are especially favored by individuals who wish to invest in real estate but may not have the time or desire to actively manage a property.
Many NNN properties have long-term leases, often with new lease terms of 10 to 25 years and typically provide multiple lease renewal options. It is important to note that although these properties may be bought or sold at any point during their lease, investors may not realize the full lease term.
NNN tenants span across a variety of property types, including office and industrial, but are most prevalent with retail properties such as fast food restaurants, convenience stores, gas stations, and big box stores. When it comes to asking prices for Triple Net properties, they are typically quoted based on a cap rate, which is determined by dividing the property’s annual net operating income (NOI) by the purchase price. A cap rate is the initial unleveraged rate of return an investment is expected to produce. Since the tenant is responsible for all expenses, net operating income is generally equal to rent paid by the tenant.
The credit quality of the tenant is perhaps the most important factor to consider when contemplating a Triple Net property. Because they only have a single tenant, the financial performance of the property is largely attributable to the tenant’s ability to pay rent over the course of its lease. Larger companies are often assigned a credit rating by a credit agency, representing the likelihood of a company defaulting on its financial obligations. All else being equal, properties occupied by strong tenants with “investment grade” ratings generally trade for lower cap rates than those with non-investment grade tenants.
While NNN properties can provide a passive investment with long-term predictable cash flow, it is important to note that NNN properties are still subject to all the risks associated with real estate investments, despite the partial mitigation of property risks by the strength of the tenant.
There are several benefits to landlords and investors interested in going the triple net lease route. For one, it provides a predictable flow of income. Landlords also do not have to stress over rising property taxes or insurance costs because the tenant handles those expenses. The primary cash flow risk for landlords is if the tenant defaults on the lease.
Triple net leases are typically long-term agreements (usually about ten years or more) with rental increases specified in the lease agreement, so landlords do not have to worry about finding new renters every year or two. Additionally, triple net leases do not require a tremendous amount of management, with landlords only responsible for taking care of bookkeeping, tax returns, and financing decisions when they arise.
The benefits of a triple net lease extend to tenants as well, providing them with more control over the property and the ability to make necessary changes as needed without having to consult with the landlord on every detail.
In conclusion, both landlords and tenants should take careful precautions and fully review the lease prior to committing to this lease structure, as there are several benefits and risks associated with triple net leases.
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