Triple net Lease in Commercial Real Estate

Home Real Estate Concepts Triple net Lease in Commercial Real Estate

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In the field of real estate, there are multiple types of agreements which are drawn among the two parties. One of them is the triple net agreement which is also known as the NNN agreement. The tenant bears most of the responsibilities related to the property. These responsibilities are in the form of expenses such as the taxes, insurance, the property maintenance and the rent as well.

These additional expenses are often called as the three nets – net building insurance, net real estate taxes on the leased asset, and net common area maintenance. If a property owner leases out a commercial building (does not apply to residential or apartment buildings), the tenant becomes responsible for paying the property taxes, insurance, and endure maintenance costs.

Since the tenant is covering the costs which are otherwise the responsibility of the owner, the rent charged in the triple net release is generally lower than the rent charged in a standard lease agreement. To calculate the lease amount, the capitalization rate is used. This is determined by the creditworthiness of the tenant.

Triple Net Lease in Commercial Real Estate

A triple net lease is an agreement which is usually applicable in places where the retail spaces are concerned. The triple net lease agreement can be classified into three different types which are discussed in the next paragraph.

Variations of the Triple Net (NNN) Lease

  • Single-Tenant Net Lease

NNN leased investments are usually leased to one single tenant and thus referred to as Single- Tenant Net Leases (STNLs). However, if an NNN lease has more than one tenant, it cannot be considered as an STNL.

For example- If Wal-Mart and Michelin share a building under two separate NNN leases or a shopping complex where all tenants are wrapped under into one NNN lease. Both examples would be considered as NNN leases but not Single-Tenant Net Leases. Although this reduces the pain of collecting several pay checks to one, it also increases the risk of defaulting. This means that in case of an STNL if either of the tenants gets bankrupt, the other tenant will have to continue to pay the rent owing to being under the NNN lease.

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  • Double Net Lease

The second variation to the NNN lease is the NN lease or the ‘Net-Net’ lease (pronounced as the double net lease) in which the tenant has to pay property taxes and building insurance in addition to base rent. Double net leases and triple net leases are usually single tenant arrangements, but here the landlord has an additional obligation to carry-out some extra financial maintenance.  Some stores like Auto Parts dealers operate under double net leases where the owner/landlord is responsible for the structure and roof of the building.

Although sometimes the NNN and the NN lease are mistakenly termed as the same, there is another difference between them. Double net leased investments generally trade at a higher CAP rate than triple net leased investments. This is because of the maintenance expenses the landlord is responsible for.

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Investing in a Triple Net lease

NNN leased properties have become a popular choice for investors looking for a steady income with relatively low risk. Triple net lease investments typically consist of three or more commercial properties that are leased by a single tenant. These commercial buildings may include office buildings, shopping malls, industrial parks or free-standing buildings used by banks or restaurant chains. A typical lease term is of 10-15 years; it consists of a built-in contractual rent escalation. This is needed because of the constant rise in expenses due to inflation.

A Risky Path

Although NNNs are considered to be highly risk-averse investments, especially, when the property is leased to a national credit tenant, the landlord is still at some risk. For example- Who would bear the resurrection expenses in case of a casualty (includes national disasters)? Also, specific risks like fluctuations in property taxes cannot be completely accounted for in the initial contract, and hence the landlord has to estimate these costs early on. In this scenario, if the landlord’s accountant doesn’t do his job correctly, it may cost the landlord thousands of bucks by the end of the taxable year. Therefore although the NNN lease investments carry low risks, they require high levels of oversight and foreseeing.

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The Benefits

  • For Investors:

In NNN leases, tenants are given the responsibility of significant expenses that include HVAC and roof repairs. This keeps the operation cost lower for the landlord. Typically NNN leases have lower rent per square foot rates which increases the tenant pool when a landlord decided to lease the property. For specific tenants, landlords frequently modify leases allowing for greater flexibility and higher tenant retention.

  • For Tenants:

Since the tenant is responsible for maintaining the building, often an NNN lease offers a lower monthly rate. The tenant can receive benefits like cost-savings while he manages the premises.

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