If you’ve been paying attention to recent Realized Holdings blogs, you’ve likely stumbled onto various commercial lease topics. Understanding the tenant/property owner lease arrangement is important before investing in a property. Also important is understanding which party is responsible for what costs, such as maintenance, taxes, and insurance.
Depending on the lease contract, a property owner/landlord/investor might pay most of the expenses (gross lease) or a few of them (triple net lease).
Then there is the absolute net lease.
Absolutely none of the expenses
Under a triple net lease, the landlord is still responsible for property maintenance and repair costs. But with an absolute net lease in place, the landlord hands those expenses to the tenant. Sometimes known as the Abs NNN, bondable lease, or even hell-or-high-water lease, the absolute net lease requires absolutely no landlord involvement, meaning it could be an ideal passive income stream.
So, why is such a lease viable for the tenant? The Abs NNN is sometimes used in sale-leaseback agreements. In this situation, a business owner might sell its property to raise capital, then turn around to lease the premises back from the new owner. An absolute net lease benefits the former-owner-now-tenant, in that insurance, maintenance, and property taxes can be chalked up to -- and deducted as -- the cost of doing business.
National credit tenants might also prefer absolute net leases on the stand-alone structures they occupy. Yes, they have to assume property expenses. They also can assume greater control over the property.
When the landlord might pay
While the absolute net lease places the expense onus on the tenant, there is one scenario in which the landlord might take on some financial responsibility. This would be through the absolute net ground lease.
A ground lease represents an arrangement, in which the tenant takes on the costs of developing and maintaining a property during a specified period of time. Through that agreement (which can span decades), the tenant pays daily operational and insurance costs, while the landlord pays property taxes on the land.
If the lease expires without renewal or extension, or the tenant defaults, the property owner assumes ownership of the building, the land, and all the expenses involved. This “absolutely” means the property owner now must pay insurance, taxes, and maintenance for the land, as well as the building on it.
Caveat investor
A property with an absolute net lease tenant arrangement could be very attractive to you, the investor. Such an agreement means that, in theory, your tenant pays for everything.
But before opening your checkbook, be sure you fully understand the lease agreement. While it could be represented as an “absolute” one, there could be tweaks or fine print, which might mean some landlord expense.
Additionally, triple net leases and absolute net leases are often confused with one another, mostly due to inaccurate information or advertising. And, if your tenant defaults, expenses revert back to you, at least until a new tenant is signed. This could spell sudden, and unplanned, upkeep costs.
In closing, while the absolute net lease can represent an attractive investment, in-depth research on the tenant, market conditions, and the lease itself is essential. Doing so can help ensure that you don’t find yourself responsible for property expenses you hadn’t anticipated.
