Triple net lease properties are one of the best available options for investors looking to generate solid capital returns from commercial real estate investments. In fact, commercial real estate investors have turned to triple net (NNN) lease properties (and the many variations thereof) more frequently during the pandemic than before, as they offer higher yields than bonds and other similar investments.
Triple net lease properties are seen as a solid investment option during economic downturns, as they provide investors with a good mix of steady income from tenants, as well as less hands-on responsibilities when it comes to taking care of the property itself. This trend of NNN properties is growing in all sectors of CRE, not just in the retail real estate market nationwide.
To help understand net leases and investing in net lease properties a bit more, we put together an Ultimate Guide to Triple Net Leases with essential definitions and more in-depth questions. Before diving into the specifics of what a Triple Net Lease is, the pros and cons of a Triple Net Lease, and details about Triple Net Lease properties, it’s important to illustrate what different types of leases exist in the first place.
Types of Commercial Real Estate Leases
Tenants and landlords can negotiate different terms for their leases based on the expenses and responsibilities that are part of the occupying and maintaining the property physically and financially. For starters, there are three types of leases that are most commonly used for commercial real estate properties:
1) Gross Leases – Gross leases are commercial real estate leases whereby the tenant pays a flat rental amount for occupancy. Meanwhile, the landlord pays for all regular operating expenses, including: taxes, electricity, and water bills.
2) Modified Gross Leases – A modified gross lease is the same as a gross lease, but in addition to the base rent, the tenant takes on a proportion of some of the other operating expenses of the property.
3) Net Leases – In a net lease, the tenant is responsible for the base rent plus one or more of the property’s expenses, depending on what type of net lease. We dive more into that concept in our next section.
Each option has different pros and cons for both parties depending on what the situation is. This is something that should be looked at on a case by case basis.
Definition of Net Lease
To further expand on the idea of net leases, there are three different types: single net lease, double net lease, and triple net lease.
In a net lease the tenant takes responsibility of the base rent plus one or more of the property’s expenses: taxes, insurance, and / or maintenance. In a double net lease, the tenant takes responsibility for the base rent plus two of the aforementioned expenses. This then leads us to the ensuing option, a triple net lease.
What is a Triple Net Lease?
A triple net lease (also known as NNN) is a lease agreement on a commercial real estate property where the tenant agrees contractually to pay the lease as well as all of the expenses of the property that usually pertain to the owner of the property.
There are three categories of expenses involved, which is why they are called triple net leases, these expense categories include:
1) Real Estate Property Taxes
2) Property Insurance
3) Maintenance of Property and Common Areas (CAM)
Are utilities included in a triple net lease?
Yes, in addition to the 3 Nets (taxes, insurance, and maintenance), utilities are also generally paid for by the tenant unless otherwise specified in the net lease agreement with the landlord.
What are examples of utility bills paid in triple net lease?
Traditionally, utility bills consist of electricity, gas, water / sewage, and garbage disposal. Nowadays cell phone, telephone, and internet bills also form part of utility costs for a business and their expenses.
What happens with major repairs to a triple net lease property?
It depends on the type of lease and the details of the specific lease for the property signed by the tenant and landlord. In a pure triple-net (pure NNN lease), typically all repairs and other maintenance costs fall under the responsibility of the tenant. However, it is fairly common now for leases billed as NNN to push responsibility for the roof and structural integrity to the Landlord. Some people call these type of leases NNN while others call them NN (representing taxes and insurance, but excluding maintenance).
Because of the lack of standardized industry terms, it is critical for tenants, landlords, buyers and sellers to read the lease terms thoroughly and carefully to ensure who is responsible for each item according to the lease document.
Triple Net Lease Pros and Cons
Not unlike many business decisions, there are pros and cons to consider before applying a triple net lease as your lease agreement.
Pros for Triple Net Lease for Tenants
The clearest benefit of triple net leases from the tenant’s perspective is that the tenant has ownership-like control over the maintenance of the property, the insurance carrier selected for the property and can protest the taxes if necessary to keep them as low as possible. Keep in mind that Triple Net Leases are only applicable to properties not shared with others, with a few exceptions. In most cases this means that the building is free-standing. In addition, because the tenant is taking on the property ownership hassles oftentimes the rent is discounted to reflect that.
Cons for Triple Net Lease for Tenants
The cons of triple net lease revolve around the work necessary to organize, contract for, manage and pay each property vendor. For example, the tenant will need to hire a landscaper, repair company, find and compare insurance policies, and protest taxes. In addition, unexpected costs that may arise during the time of occupancy of a particular property. The two primary expenses that may fluctuate are:
- Tax Liabilities
- Maintenance Costs
When it comes to taxes, the tenant will be responsible for their liabilities, such as with fines, penalties, or other costs associated with incorrect declaration of taxes on the property.
When it comes to maintenance costs, there are always possibilities of items breaking or damage within the property. These can result in unforeseen repair costs that fall under the tenant’s responsibility per a triple net lease agreement.
Pros for Triple Net Lease for Investors
Less management hassle
Since utility expenses, repair costs, and taxes (sometimes) fall under the tenants responsibilities in a triple net lease, the landlord has much less to worry about vis-a-vis management of the property itself. Obviously if bigger issues arise with the property, such as structural repairs, they must be dealt with according to the lease provisions to determine who must pay for the repair. Most investors who prefer net leased properties prefer to have as few responsibilities as possible. The investor’s desire is to have mailbox money – rent that appears each month without the investor having to deal with the property or tenant at all.
Steady, predictable revenue stream
This is also a major pro when considering investing in a triple net lease property, as it provides a steady, predictable revenue stream on a monthly basis. Coupling that with minimum hands-on management makes NNN an attractive option as an investment.
Cons for Triple Net Lease for Investors
The risk of having a single tenant is that if the business isn’t viable or goes under, then the contract will be broken eventually. This cuts off the steady revenue stream, begins the quest for a new tenant to fill the NNN space, which is not always easy or cheap. Finding good, dependable tenants is always a challenge. The cost to retrofit the property might be significant and there will be downtime in between tenants resulting in no rental income and no reimbursement of the taxes, insurance or maintenance while the building is vacant.
Triple Net Lease Properties
Why should anyone invest in NNN properties? What makes them attractive?
As mentioned in the beginning of the 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 longterm contracts. They are also very hands-off when it comes to management and expenses, because the tenant takes on most of those expenses directly. Many investors utilize a 1031 deferred tax exchange as well, which is a significant tax benefit that drives the demand for NNN investments up.
Who are typical net lease tenants?
The best (and coincidentally most typical) net lease tenants are considered “recession-proof” tenants. They 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.
Where do you find triple net lease properties?
Most buyers search the web and use sites like Crexi and Loopnet to find properties or they utilize an investment sales broker to find and negotiate them. N3 Real Estate does not advise clients on investment sales; however, we have developed or purchased several triple net lease properties in our retail real estate portfolio as examples of the types of NNN properties you may see on the market.
Triple net lease properties are most often developed under a build-to-suit agreement with the tenant. Our retail real estate experts can help with any inquiries you may have regarding triple net leases, net lease development, or other questions with restaurant / retail real estate in general.