In a triple-net (NNN) lease investment, the initial lease will eventually expire, and the tenant will have the option to renew. Most investors want the occupant to renew as this provides the smoothest process. However, there’s no telling how tenants will act after the lease is over. This uncertainty creates renewal risk, and being unprepared for it can result in future vacancies or disrupted cash flow.
In this article, Realized 1031 discusses strategies for managing renewal risk in triple net lease agreements. Check out the guide below to help you make more confident investment decisions.
NNN leases are contracts with a set term, lasting 10 to 15 years or more. After this initial agreement, tenants can choose to renew their lease. Renewal risk is the uncertainty about whether or not the lease will be renewed. If a lease isn’t renewed, several problems may arise, including the following:
Many factors can heighten renewal risk. Some, such as lower demand in the tenant’s industry, are usually beyond landlords' control. Other factors, such as the lease terms and the landlord's relationship with the tenant, can be influenced by the landlord. For these considerations, there are strategies you can employ to help mitigate renewal risk.
While renewal is the best-case scenario, it’s not always the preferred choice. You wouldn’t want to renew with a tenant who may find it harder to pay the three net operating expenses in the future. To decide whether or not you wish to renew with the tenant, make sure to evaluate them well before the lease even begins.
If you believe that renewing with a prospective tenant is beneficial for the investment, then make sure that the lease itself is written to make renewal easier and reduce risk. There are a few provisions you can include, such as multiple renewal options that give tenants flexibility. Having early exit penalties can also help, as these fees can strongly discourage tenants from abruptly leaving the contract. Finally, you can include early renewal clauses that help tenants decide early on whether they’re renewing or not. This clause helps reduce uncertainty.
Another strategy you can employ to keep your original tenant is to keep the property in excellent condition over the years. Monitoring the asset and implementing necessary capital repairs or upgrades gives the occupants more reason to stay rather than risk transferring to a new property.
A strong relationship with tenants is often the deciding factor in renewal. Open communication, responsiveness to tenant needs, and collaborative problem-solving create goodwill. When tenants feel supported, they are less likely to look elsewhere.
Renewal risks can be managed by investors who plan ahead. Assessing the tenant, structuring leases to streamline renewals, and maintaining strong tenant relationships can help you avoid risks such as vacancies, reduced income, or unfavorable lease terms. By taking these proactive steps, you’re better prepared for the future success of the NNN investment.
Sources:
https://www.investopedia.com/terms/t/triple-net-lease-nnn.asp