As a real estate investor, you have many options available to you. There are residential properties and commercial properties, and both have unique types of leases that benefit tenants and landlords. One of the most beneficial leases in commercial real estate investing is the Triple Net Lease.
Keep reading to get a full introduction to Triple N Lease commercial real estate investing.
What Is a Net Lease?
According to The Law Dictionary, a net lease makes the tenant responsible for certain aspects of the property that are usually paid for by the investor. Net leases are very common in commercial properties.
Net leases come in several variations, including single net leases, double net leases, absolute net leases, and triple net leases.
A single net lease requires that the tenant pays for the property tax. All other costs are the responsibility of the real estate investor. In a double net lease, the tenant is responsible for the property tax and insurance.
A tenant of an absolute lease has the most responsibility. They must cover the property tax, building insurance, common area maintenance, and structural building maintenance. This is an excellent option for investors because they are essentially responsible for nothing.
Each net lease type denotes different financial responsibilities on top of rent for the tenant. However, rent on net lease properties is generally lower to compensate for these additional costs.
Additionally, net leases tend to have longer contracts. The average for a triple net lease is 10-years. This is because the control the tenant has over the property can only be beneficial over the long term.
How Does a Commercial Triple Net Lease Work?
A triple net lease requires the tenant to be responsible for a majority of operating expenses.
In a triple net lease, these costs include:
- Property taxes
- Building insurance
- Common area maintenance costs
Let’s take a closer look at what each of these costs means and how they affect your cash flow.
These are the taxes levied on a building based on its value. Property owner taxes vary widely from place to place. However, commercial properties are often worth more than residential ones. This means that the taxes are often higher.
Removing property tax from your budgeted costs can free up a lot of funds for other projects.
Every commercial building is required to have property taxes and building insurance. Commercial property insurance protects against damage caused by a wide variety of things. These include fires, acts of God, or storm damage, depending on the individual policy.
Common Area Maintenance Costs
While it may seem obvious, this is the maintenance of the common areas of the building. However, calculating common area maintenance can be complicated, depending on your property and the number of tenants.
First, you have to define your common areas. These are areas that are accessible to all tenants and guests. Common areas may include hallways, restrooms, parking lots, etc.
To get the total cost of maintenance you want to add up things like janitorial services, landscaping, and security. Any service that is used to better the environment for all tenants.
You then take that cost and divide it between your tenants. According to the Institute of Real Estate Management, the easiest way to do this is to divide the total common square footage by tenant.
Rent is used in two ways for triple net leased properties. First, rent is often charged on top of the other costs mentioned above. This is often an adjusted rate to compensate for those other fees.
Secondly, base rent is often the term used to refer to the monthly payment made to the landlord for all the fees and taxes required of the tenant.
According to the Commercial Real Estate Development Association (NAIOP), there are two main rent models. The Gross Rent model, and the Triple Net Rent Model. The main difference is how things are paid.
In the Gross Rent model, the landlord pays for the expenses directly from the tenant’s rent. In this model, tenants have a set amount they are required to pay each month. However, should pricing change on any aspect of the taxes or maintenance fees, this can cause a risk to the landlord.
In the Triple Net Rent Model, tenants pay expenses directly as they are billed. This can either be done directly to the respective billers or the landlord. The landlord then passes along the full payment collected from each tenant.
This is the far less risky method in some ways, as it is not dependent on costs remaining the same. However, if one tenant doesn’t pay their part, it can still pose a risk to the landlord.
What Are the Tenant Benefits?
Any commercial property can qualify for a triple net lease. Residential properties are generally not permitted to use this lease.
Tenants have to get some benefit to be willing to take on so much cost. The primary benefit for tenants is customization. Triple net lease tenants have total control of their workspace. The company can purchase its furniture, remodel the interior, and essentially create its ideal store.
Many businesses cannot afford to build a company where they want to. Instead, they can look into a triple net lease and get the benefits of a customized space without sacrificing location.
Triple net leases may also be a more affordable option for many businesses. The operating costs on a triple net lease may be higher than other commercial leases. However, the ability to create a custom store without purchasing a building outright may outweigh the costs.
The Pros and Cons of a Triple Net Lease
There are pros and cons to a triple net lease. Let’s go over what works and the risks for investors like you.
Pros to a Triple Net Lease
- You are responsible for fewer fees related to the property. This means you have more money to make other investments or save for a rainy day. There is no such thing as too much money, right?
- Triple net leases are a great way to diversify while building your nest egg with relatively low risk.
- Triple net leases ensure a long-term, passive income. Net leases generally have longer terms, allowing you to sit back and enjoy that income for, on average, a decade.
Cons to a Triple Net Lease
- You lose some say on the state of the property. While you get to choose your tenants, you do not get much say in what they do with their stores. While this may be freeing for some, those who have a more type-a personality may find it frustrating to own a building but not have total control of its stores.
- You are dependent on the success of someone else’s business. Most contracts will have clauses to protect the landlord should a tenant’s business fail. However, there is still an inherent risk to landlords. If a business fails, you can lose rent while trying to find a new tenant.
How to Ensure Your Investment Succeeds
So, you think that a triple net lease is ideal for the property you are buying. That’s great. Give yourself the best chance at success by following these steps.
Step One: Find the Right Property
There are a lot of real estates investment properties out there. If you want to offer your tenants a triple net lease, you want them to feel the property is worth it. This means considering the location, versatility, and amenities of the building.
Step Two: Choose Your Tenants Wisely
If you want guaranteed income, you want reliable, successful tenants. To that end, you want to review clients thoroughly before you offer them a lease agreement.
Review the viability of their business, and take the time to check into the local market. Ensure there is an audience for what the tenant, and by extension, you, are offering as the landlord responsible.
Step Three: Build a Solid Contract
The amount of risk you are taking on as a landlord directly corresponds to the strength of your contract.
For example, do you have any clauses in the event of a company going bankrupt? Who is responsible for returning a store to its original state after a company leaves? Is your rent standardized or does it vary by month?
Step Four: Have a Professional Help You
There is so much to do when investing in a commercial property. No matter what type of lease you will be using.
One of the primary ways new investors struggle is by calculating costs and rent incorrectly. This is detrimental.
Even with your tenants covering most of your operating costs, bad things can still happen. As the landlord, you are responsible for the building maintenance.
If you are not charging appropriate rent, you may find yourself without the funds to fix big-ticket issues in your building.
Final Thoughts on Investing in NNN Property
Commercial triple net leases can be an excellent investment. As with all investments, however, they come with their risks. The best bet is to reach out to a professional to help you through the process.
A professional can ensure you can make the best decisions for yourself and your financial future. Contact us today to speak with a NNN lease agent.