Investing in a triple net lease (NNN) property has become a popular strategy for various types of investors, offering steady and predictable income for the long term. While this structure does provide reliable returns, there are still lots of variables. Cash flow management, therefore, is a critical consideration in triple net lease investing.
Below, Realized 1031 shares the basics of this process to help you monitor, plan, and optimize your income stream.
Understanding NNN Cash Flow Management
What is cash flow management? This is the process of planning, tracking, and controlling the inflow and outflow of cash within an investment, which in this case, is the NNN property. This type of lease structure assigns three net operating costs to the tenant: property taxes, insurance premiums, and maintenance costs. This shift in responsibility does simplify cash flow management, but there are still other elements at play.
- Base Rent: The main source of cash inflow is the base rent paid to you by the tenant. It’s predictable and often fixed for the lease term.
- Financing Costs: While the tenant obligation removes net operating expenses from the equation, financing is still one major cash outflow element that diminishes the money you receive.
- Vacancy Risks and Other Unexpected Expenses: These are major scenarios that deplete or disrupt your cash flow.
Financing and Leverage
Buying property in cash eliminates the need for financing, but many investors do not have the equity for this method. As such, financing is usually at play in cash flow management. The main goal is to achieve positive leverage, which means that rental income exceeds debt payments. One way to ensure a positive leverage is to enter loan terms that don’t strain monthly cash flow. Check the interest rates, amortization schedules, and other fees that could cut into your returns.
Planning for Vacancies and Unexpected Costs
Vacancies can occur if the tenant defaults, resulting in disrupted cash flow. This is a major issue in NNN leases, given how the properties usually only house one tenant. There are also major capital fixes or improvements that landlords remain responsible for. Without proper planning, these possibilities could result in loss of income. To better prepare for such occurrences, here are some cash flow management tips.
- Maintain cash reserves equal to several months of debt service
- Diversify holdings to reduce dependence on one tenant or property
- Evaluate tenant creditworthiness before signing or renewing a lease
Importance of Lease Structures and Escalations
The lease terms themselves can be used for triple net cash flow management. One clause that can provide a cushion during periods of economic volatility is the rent escalation clause. These provide language that allows you to increase rent on a regular basis (typically annually) to match inflation.
It’s also best practice to negotiate lease terms thoroughly. In particular, the tenant and the landlord must determine who pays for what, especially non-operating expenses that fall into a grey area. That way, you can avoid disputes and unexpected responsibilities in the future.
Optimizing Cash Flow Over Time
Once you’ve entered the lease, it’s crucial to implement other strategies that help with cash flow optimization. One best practice is to inspect the property regularly for cash issues early and avoid major repairs. Communicating with the tenant is also important to anticipate any challenges. Finally, we recommend reassessing financing to take advantage of better loan terms when possible.
Wrapping Up: Triple Net Cash Flow Management
Cash flow management in an NNN lease may seem complex at first, but breaking down its elements and how they affect cash inflow and outflow makes things simpler. By understanding how financing, vacancies, lease structures, and tenant obligations affect income, investors can make informed decisions and safeguard their long-term financial success.
Sources:
https://www.thepropertist.com/blog/understanding-the-rent-escalation-clause-392
