When you think of the word ‘lease,’ paying rent to a landlord is probably the first thought that comes to mind. However, there are many different types of lease structures used throughout the commercial real estate industry. In this article, we will discuss the triple net lease (NNN) and how it compares to other lease structures.
With a triple net lease, in addition to paying rent, tenants are also responsible for paying property taxes, insurance, and maintenance on the property they are leasing. This means that the tenant will typically pay a lower base rent than they would with a gross lease. You are probably more familiar with a gross lease; most residential leases are gross leases. In a gross lease, the landlord handles all of the expenses and factors them into the tenant’s monthly base rent upfront.
There are various net lease options available beyond the triple net lease structure. The first option is a single net lease, which is when the tenant is responsible only for paying property taxes plus base rent. The second structure option is a double net lease, where the tenant is responsible for paying taxes and insurance on top of base rent. Tenants under a triple net lease also have to pay for property maintenance. Essentially, in a triple net lease, most of the financial burden is placed on the tenant.
There are several benefits for landlords and investors who are interested in going the triple net lease route. For one thing, it provides a predictable flow of income. Landlords also don’t have to stress over rising property taxes or insurance costs because the tenant handles those expenses. The primary cash flow risk for landlords is if the tenant defaults on the lease.
Also, triple net leases are typically long-term agreements (usually about ten years or more) with rental increases specified in the lease agreement, so landlords don’t have to worry about finding new renters every year or two.
Triple net leases also do not require a tremendous amount of management. The landlord is only responsible for taking care of bookkeeping, tax returns, and financing decisions when they arise.
The benefits of a triple net lease don’t only apply to landlords – there are several benefits for tenants as well. Tenants have more control over the property and can make necessary changes as needed – they don’t have to consult with the landlord on every detail.
Triple Net Lease Drawbacks
Although the triple net lease structure might sound like a dream for landlords, there are some drawbacks as well. In some scenarios, there is limited upside for landlords because the returns are not guaranteed to keep up with the pace of inflation over the course of the 10+ year lease. It is best to think of this lease type as similar to a treasury or municipal bond because those offer a fixed return rate, just with a different credit rating. Also, after a property has been occupied by the same tenant for 10+ years, the space may require significant tenant improvements to make it suitable for the next tenant.
Because the building’s maintenance is managed by the tenant, an irresponsible renter may choose to let certain repairs slip through the cracks or use cheap band-aid solutions to mask larger issues. If this happens, you as the landlord may be responsible for covering costly repairs that have been left untouched over the lease’s 10+ year period. To keep this from happening, it is advisable to have strict maintenance guidelines included in the lease.
In conclusion, there are several pros and cons to a triple net lease. Landlords who want to avoid the stress and confusion of paying taxes, maintenance, and insurance can enjoy the benefits of having a tenant in place to maintain those costs. On the flip side, it could prove to be a more expensive option in the long-term if the tenant doesn’t properly maintain the space. For tenants, it could be a cost-effective option to get discounted rent and manage the property taxes and expenses on their own. However, it could also prove to be more expensive in the long-term if taxes and various other expenses see a significant increase over the 10+ year lease period. Both landlords and tenants should take careful precautions and fully review the lease prior to committing to this lease structure.