Sep 1, 2022 15 Min read
Commercial real estate investors have many options to choose from when it comes to leasing agreements. Triple net lease (or “triple-net” or “NNN”) properties have risen in popularity due to their relative stability and high earnings potential.
But what is an NNN lease? Are triple net leases a sound investment compared to other leasing structures? If you have questions like these, read on. This guide will explain how to triple net leasing works and how it might benefit your investment strategy.
In a typical real estate agreement, a tenant or lessee pays the landlord rent, and the landlord bears the responsibility for taxes and maintenance. A triple net lease passes on these responsibilities to the tenant.
A triple net lease is a formal agreement on a property where the tenant agrees to pay all of the expenses on the property. This means that the tenant or lessee will pay rent on the property as well as three additional fees:
Triple net leases are commonly found in commercial real estate. Usually, the tenant pays a lower rent since they’re assuming these other costs.
Some of the most common NNN spaces include properties such as retail and office properties. It’s common for landlords to assign different tax and insurance costs to their tenants based on the amount of square footage their business occupies.
It may be helpful to compare NNN leases with other types of net leases. A net lease is a commercial real estate lease in which the tenant/lessee is required to pay a portion of the overhead costs on a particular property. These usually include taxes, fees, and maintenance costs.
Net leases can be single, double, or triple, depending on the amount of responsibility the tenant takes on.
In a single net lease, the tenants are required to pay the property taxes on the rental property in addition to their monthly rent. Other expenses remain the responsibility of the landlord, who continues to pay for building insurance and any maintenance fees.
Single net leases are relatively uncommon, as they transfer only a minimal amount of risk from landlord to tenant.
In a double net lease, the tenant pays for both property taxes and insurance premiums as well as their monthly rent. The landlord handles the cost of maintenance. These sorts of leases can be popular because they reduce the cost of rent without burdening tenants with unpredictable maintenance costs and fees.
Commercial real estate investors love net leases because they absolve owners of some of the risks and costs of property ownership. In a triple-net lease, lessors carry the least amount of risk since their tenants carry the responsibility for insurance, maintenance, and taxes.
However, most NNN leases are slightly more complex than this simple arrangement. A typical triple-net lease can include many different clauses and stipulations. Here are a few of the most common.
Rent should already be part of any leasing agreement, but a rent clause can help modify this requirement. For instance, a rent clause can be used to include automatic rent adjustments (e.g., a rent increase/decrease after one year).
Some NNN leases include a termination clause that specifies a period of time in which the lease is operative. This clause allows tenants to evaluate the viability of the commercial space relative to their anticipated growth. It also protects investors from tenants who don’t maintain the property as well as might be expected.
A renewal clause can also allow tenants to continue the lease after the original term expires. The most common NNN lease terms range between 10 and 15 years.
A property use clause sets parameters on how the tenant may use the commercial space. In some cases, this may be influenced by zoning restrictions already in place in your area, though landlords can also stipulate the type of business activities that the building may be used for.
As in any leasing arrangement, credit matters. But for triple net leases, landlords need to be certain that tenants are capable of handling the financial responsibilities of managing the property.
Ideally, you’ll want to lease the property to “credit tenants,” which refers to those with a strong credit history and a high probability of making regular, timely payments.
How can you identify a strong credit tenant? You’ll need to look at the tenant’s third-party credit ratings. Standard & Poor’s (S&P), for example, use the following credit rating scale:
These ratings indicate the tenant’s ability to meet their financial obligations. It’s possible to have a score below a “BBB” (e.g., BB, B, CCC, CC, C, and D), but these represent non-credit tenants. Leasing to non-credit tenants carries an enhanced risk that you won’t receive rent payments on time, or that the tenant will not maintain the property as agreed.
Tenants who enter into a triple net lease will assume the responsibilities of taxes and insurance as well as something called “common area maintenance.” This usually includes things like:
However, this arrangement doesn’t mean that landlords assume no responsibility. Depending on the structure of the lease, landlords may still be responsible for the building’s structure, the roof, or even the parking lot.
There are many pros and cons of a triple net lease, and it’s important for investors to consider how NNN leases impact both themselves and their tenants.
Here are some of the advantages of a NNN lease.
For investors, a triple-net lease offers the chance for consistent income. And because the tenant is responsible for overhead costs and maintenance, the income you collect on an NNN property can be passive income. It’s true that the rent you receive will be lower than other forms of leasing agreements, but the reduced risk and hassle is often worth it.
One of the biggest advantages of NNN leasing is the lack of risk that the landlord takes on. The tenant will be paying for all of the costs of the property, from property tax to insurance to regular upkeep. That means the less financial risk for investors.
While it’s not a requirement, many NNN properties are located in favorable areas. This means that businesses looking for commercial space can take advantage of the proximity to other businesses and a steady stream of car or foot traffic. These benefits make it easier for investors to attract tenants to their property.
Because the tenant is juggling the core responsibilities and costs of the property, they typically pay lower rent. Sure, that might mean you earn less each month as an investor, but it does make it easier to attract and retain lessees to your property.
It’s also important for investors to consider the disadvantages of NNN leasing. Here are some of the drawbacks to a triple-net lease.
The lower rent is something of a double-edged sword. On the one hand, it makes it easier to attract and retain quality tenants. On the other hand, it means you’ll earn less each month. For most investors, this drawback is offset by the fact that NNN leases come with less risk and less work. This can make them worth it overall.
Depending on how your lease agreement is structured, your tenants can be locked in for an extended period. Without a rental clause, you won’t have the ability to increase the rent to reflect changes in the property values in the area. This can effectively create an earnings cap for your business, limiting your potential profits.
One way to avoid this is to set clear lease terms or rental clauses that will provide a way for you to make adjustments to the rent on a more frequent basis.
Many tenants are attracted to NNN leases for the lower rent requirements. Unfortunately, these tenants can discover that maintenance costs are higher than they initially anticipated, or they can have trouble navigating the procedures and risks of paying property taxes.
These issues can prompt them to try to get out of their leases or secure better conditions. Landlords can prevent this with something called a “bondable net lease,” which prevents tenants from terminating or altering the lease prior to the expiration date.
A triple-net lease can be a great, no-hassle strategy for investing in commercial real estate. As an investor, it might be one strategy for managing your portfolio.
At Terrydale Capital, we’re committed to devising a game plan that works for you. We can advise you on loan programs and investment strategies to help you succeed. To learn more, contact us today.
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