When it comes to the potential advantages of investing in a triple net lease in California, here’s something to consider: one of every eight people in the United States lives in the Golden State.¹
California is massive – it’s the third-largest state in the nation behind Alaska and Texas. The state’s population is enormous as well – California is home to nearly 40 million people. Though California has experienced a well-documented exodus of both residents and businesses in recent years, it still boasts the largest gross state product in the nation at more than $3.35 trillion, which is roughly 15 percent of the economy of the United States.²
California’s economy is also incredibly diverse. From the well-oiled entertainment machine of Hollywood to the microchips, technology, and venture capital of Silicon Valley to the hundreds of agricultural crops grown in the Central Valley, California leads the way in countless industries. California also is one of the most-visited states in the U.S. – more than 213.5 million people traveled to California in 2021.³
These factors are just a handful of the reasons institutional and retail real estate investors alike park their investment capital in the Golden State. Below we’ll take a look at triple net leases and some of the factors investors must deal with when purchasing triple net lease properties in California.
What Is a Triple Net Lease?
Triple net leases are also called NNN leases and single tenant net leases. Tenants typically are the sole occupants of standalone buildings.
Under a NNN lease agreement, the tenant agrees to pay a pro-rata share of all the property’s operating expenses, such as maintenance, taxes, and insurance, along with their base rent. Commercial real estate investors often prefer this type of lease agreement because they don’t have to worry about daily operations of the asset. Triple net lease assets also can pose less risk for the investor since the lessee is responsible for covering building maintenance and repairs, as well as fluctuations in insurance or property taxes.
Triple net leases are usually inked for 10 to 15 years, but they can be for 20 years or more in some instances. That longevity offers the potential for a steady income stream for up to a score of years, and property owners can realize additional asset equity on longer hold times by using a portion of their tenant’s lease payments to pay down their commercial mortgage loans.
Disadvantages of Triple Net Leases: California’s Business Tax Structure
California’s tax structure is widely regarded as less business-friendly than other states. The Golden State has a flat 8.84 percent flat rate corporate tax that’s levied on all C-corps and any LLCs that choose to be treated as corporations by reporting net taxable income. The alternative for LLCs is to pay California’s alternative minimum tax, which is 6.65 percent. Any C-corps that don’t have net income to report, as well as pass-through entities such as S-corps, LLCs, and limited partnerships must pay the state’s franchise tax, which is based on net income. It varies from $800 if net income is less than $250,000 and jumps to nearly $12,000 if net income exceeds $5 million. Sole proprietorships and general partnerships are exempted from the California franchise tax.⁴
As a final point, California charges a combined average of 8.82 percent for state and local taxes on retail sales.⁵
A few of the other potential disadvantages for investors of NNN lease properties California include limited upside due to long-term fixed rents, high turnover costs if the tenant vacates the property at the end of its lease, and difficulty finding a new tenant if the space does go dark.
The Bottom Line
Investors likely will find many triple net lease investment opportunities in California, especially in major metropolitan areas. Many of these businesses rely on strong foot traffic to generate sales. A few examples of NNN lease businesses include banks and credit unions, coffee shops, drug stores, restaurants and quick-serve eateries, convenience stores, and auto parts retailers.
While there can be many advantages of investing in triple net lease properties in California, investors should consider how the state’s tax structure could impact potential returns and weigh those opportunities against similar investments in states that have less onerous tax laws.
Sources:
1. California’s Population, Public Policy Institute of California, https://www.ppic.org/publication/californias-population/
2. Gross Domestic Product: All Industries in California, Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/CANGSP
3. California Travel-Related Spend and Visitation Forecast, Visit California, https://industry.visitcalifornia.com/research/travel-forecast
4. The Small Business Owner’s Guide to California State Taxes, Bench, https://bench.co/blog/tax-tips/california-state-taxes/
5. How High Are Sales Taxes In Your State, Tax Foundation, https://taxfoundation.org/2022-sales-taxes/
