Triple net (NNN) leases provide a clear-cut way to divide financial responsibility between tenant and landlord or property owner. If you’re an investor, you may find this structure appealing. There’s a promise of hands-off involvement on your end, resulting in passive income. But are you truly free from any responsibility, or are there other costs that NNN leases don’t cover? What are the specific responsibilities for tenants and landlords in this type of lease?
Below, Realized 1031 answers these questions. Let’s take a closer look.
The most straightforward lease structure is the gross lease, where the tenant only pays for base rent and the landlord handles everything else. However, commercial properties usually have net leases, which allow the tenant to handle other net operating expenses to give more flexibility and control over the asset.
NNN leases are arrangements that assign all net operating expenses to the tenant. These include property taxes, insurance premiums, and maintenance costs. Handling all these expenses gives tenants full control of the property, allowing for customized coverage or property modifications that help with their operations or branding needs. For investors, the NNN lease eases the burden of landlord responsibilities and ensures steady passive income.
The bulk of financial responsibilities falls to the tenant in an NNN lease. Other variations, like the N or NN lease, only partially assign net operating expenses to the occupants. But with triple net leases, the tenants basically step into the role of managing and maintaining the property. Here are their key responsibilities in this arrangement.
Tenants will be responsible for paying property taxes upon entering an NNN lease. These are due to the local governments, as there is no federal property tax in the U.S. This means that rates are variable depending on the state or city where the property is located.
There is also unpredictability given how property taxes may rise and fall. However, the general trend is that property tax payments are rising everywhere in the U.S. As such, tenants must prepare for these annual or semi-annual payments with enough funds to avoid tax penalties. The average property tax in the US is 1.22% of the property value, but some states see as much as 1.83%, like Illinois.
NNN leases also require the tenant to handle insurance coverage. This arrangement is advantageous for the occupants since it allows them to tailor their coverage beyond property insurance, which is usually the only coverage the landlord provides in a gross lease. In an NNN lease, tenants with more specialized operations have more flexibility to include other types of coverage.
Insurance premiums are still vulnerable to market conditions, and payments may rise due to factors such as inflation. As such, tenants must balance the protection they need against the rise in premium costs.
The final net operating expense that NNN leases assign to the tenant is the maintenance costs, which include day-to-day operations. These costs include the following and more.
By maintaining the property, tenants safeguard the functionality of their business while preserving the long-term value of the asset.
Aside from the net operating expenses, the tenant will handle other overhead expenses involved with property operations. These include utilities, waste management, and property security. There are overlaps here, and negotiations become necessary to ensure that each party is on the same page before entering the NNN lease.
Overall, the heightened financial responsibility may seem burdensome to tenants. However, NNN leases usually attract large or national companies with excellent creditworthiness and financial backing to handle these expenses. As such, investors can be confident that the tenant is more than capable of maintaining the arrangement.
NNN leases promise passive income to landlords, but there are still responsibilities you must take on as the direct owner of the real estate asset. Things are certainly not as involved as with a gross lease, but handling these duties is still important to preserve the value of your property and ensure a smooth run of the NNN lease.
The first non-operating expense you remain in charge of is maintaining the structural components of the building. Examples of these are the roof, foundation, and exterior walls. These are considered non-operating expenses since they go beyond day-to-day maintenance and often require significant capital to fix or replace. When these responsibilities remain with the property owner, they can stay directly in charge of the structure’s long-term usability and value.
Tenants handle property taxes, insurance, and maintenance. However, it will still be up to the investor or landlord to monitor and ensure that these obligations are satisfactorily addressed. You may check for proof of insurance or verification that property taxes are current. Failure to maintain oversight may result in non-compliant tenants and legal or financial consequences for property owners in the future. For example, unpaid taxes can result in liens on the property.
Investors will also remain in charge of major capital improvements on the property. These may include renovations, environmental compliance upgrades, or code compliance projects. Given how these expenses fall outside of normal maintenance, the capital improvements are considered non-operating expenses.
In summary, landlords take on an investor role over the real estate asset, while the tenant serves as the manager. The former’s primary role is ensuring that the property retains its value and minimizes vacancy risk. The NNN lease may drastically reduce the owner’s role, but they remain ultimately accountable for the asset’s condition and long-term marketability.
In property management, there are expenses that blur the line between operating and non-operating expenses. These costs are often the subject of negotiations when creating the lease agreement. Here are a few examples of these expenses.
What can be considered simple maintenance? What is major enough to be a capital improvement? What qualifies under these two categories is often a topic of debate between tenants and landlords. For example, a faulty HVAC system can be addressed with a simple duct replacement, but as these replacement escalates, at what point do several “simple” duct installations become capital improvements? Setting defined values is one way to avoid confusion.
While landlords usually cover major structural repairs, some NNN leases push certain costs, like partial roof repairs, onto tenants. This is negotiable, and tenants should carefully review contract terms to avoid unexpected bills.
New zoning or environmental regulations may arise, requiring upgrades on the property to remain compliant. These expenses may also be part of negotiations between the tenant and the landlord. For example, major upgrades should typically be shouldered by the landlord. However, the tenant may contribute if the changes are directly tied to their operations. For example, a tenant in the manufacturing industry may help with costs if the property needs to install a waste disposal system to comply with new environmental regulations.
Success in the NNN lease depends on your careful planning and oversight, especially on the expenses you’re not responsible for. Make sure to follow these best practices.
NNN leases may seem like they’re providing a clear outline of what tenants are responsible for: property taxes, insurance premiums, and maintenance costs. However, there are still non-operating expenses that landlords or property owners must stay in charge of, such as capital improvements and structural maintenance. These investors must also ensure that the tenants are actually handling the net operating expenses to avoid legal issues and ensure long-term marketability of the property.
In summary, landlords still have a lot of responsibility even with NNN leases. These obligations are not as involved as daily operations or maintenance, but they are crucial to preserving the property’s value and avoiding significant financial and legal risks.
Sources:
https://www.newsweek.com/america-property-tax-headache-2065595
https://www.investopedia.com/terms/t/triple-net-lease-nnn.asp