Triple Net Lease Guide for Commercial Real Estate Investing
Triple Net leases are real estate lease agreements where the tenant pays a defined portion of expenses beyond the rent to the landlord. For example, property taxes, insurance premiums, utilities, property maintenance and repair costs. Net leases are commonly used in commercial lease agreements and are less common in residential leases.
There are several different types of net leases, and in this article, we’ll explore triple net leases as well as other net lease types. (It should be noted that while the descriptive categories here are generally followed, landlords and tenants may always negotiate modifications to suit their mutual purposes.)
What is a Triple Net Lease?
A triple net lease, also known as a net-net-net or NNN lease, insulates the landlord of the obligation to cover all expenses mentioned above such as property taxes, insurance premiums, utilities, maintenance, and repair costs.
The tenant is responsible for paying rent as well as all expenses. Most often, triple net leases are long-term (10 years or more) and they generally include provisions for rent increases.
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Top 3 Triple Net Lease FAQs
Here are the top three triple net lease (nnn) questions and answers. To view an even larger list, please visit our NNN Lease FAQ..
Why Purchase A Triple Net Leased Property?
Triple net leases offer much more predictability of income compared to other real estate investments. This is because of the fact that maintenance and almost all the expenses of the property including taxes, building insurance, maintenance, etc. are the responsibility of the tenant
Are Utilities Included In A Triple Net Lease?
Under most circumstances, utilities are paid for by the tenant. That being said each lease is unique and we include legal counsel in reviewing our leases & suggest the same for all our clients.
How Is Triple Net Lease Calculated?
Typically it is a negotiation between a landlord and tenant with the lease being established based on market conditions
What Does the Landlord Pay in a Triple Net Lease?
In a triple net lease, the landlord is generally responsible for structural and roof-related maintenance and repair costs. Additionally, they often take on the responsibility of paying the taxes, insurance premiums, and so forth directly using the tenant’s payments to avoid the risk of late fees or penalties.
With a triple net lease, the landlord has a lower level of risk since the tenant has assumed the majority of the costs.
What Does a Triple Net Lease Include?
A triple net lease includes rent costs as well as property taxes, insurance premiums, and basic maintenance and repairs. The tenant is responsible for covering all of these costs, although their rent will generally be lower as a result.
1031 Exchange and Triple Net Leases
Triple net leases can be combined with §1031 exchanges to really maximize your investment. §1031 exchanges allow you, as an investor, to sell a commercial income property and defer the resulting federal and state income taxes, as long as you purchase a like-kind property using the proceeds of the sale within a certain time period as well as adhere to the other §1031 guidelines.
The like-kind property must be of equal or greater value than the one you sell (or else you could pay taxes on the difference) and it must be the same in nature or character without regard to grade or quality. Due to the Tax Cuts and Jobs Act of 2017, only ‘real property’ as defined by the Internal Revenue Code is eligible for a §1031 exchange.
Personal property does not qualify and any transfers including personal property could be taxable. Additionally, the replacement property must be identified within 45 days and the entire exchange must be completed within 180 days. There are more rules and requirements for an exchange to qualify for §1031 treatment; however, the basics above still apply.
If you use a §1031 exchange to purchase a triple net lease property, you could potentially defer the federal and state income taxes while also setting yourself up for a reliable passive income stream that is also very liquid and easy to sell should the need arise.
The law does not limit how many §1031 exchanges you can do in a year, so you can trade up your properties as many times as you want or trade-in residential rental properties for easier-to-manage, lower risk triple net lease properties.
NNN Lease Qualifications
To qualify for a §1031 exchange, the NNN lease must meet the definition of “real property”. This can be achieved in multiple ways. For example, if the underlying real estate will remain owned by the investor, then the length of the NNN lease doesn’t matter. If at the end of the NNN lease the investor will have no residual ownership then, at the time of the exchange the NNN lease must have a minimum of 30 years remaining.
In certain circumstances, if the lease provides for optional renewal periods, these periods can be included in determining whether the leasehold has 30 years or more remaining. (See Case 15 T.C.M. 1058 – R. & J. FURNITURE COMPANY v. COMMISSIONER, United States Tax Court.).
Leasehold interests are more important than ever due to the Tax Cuts and Jobs Act of 2017 because personal property exchanges have been eliminated from section §1031 and only ‘real property’ is eligible for this treatment. This puts additional pressure on the definition of ‘real property’ for like-kind exchanges, and 30-year plus leases are included under that definition.
Special Triple Net Lease Considerations
Typically, triple net lease investment portfolios consist of three or more high-grade commercial properties that are leased by tenants who have existing cash flow already in place. These types of high-grade properties can include office buildings, industrial parks, shopping malls, or freestanding buildings that are leased by banks, pharmacies, restaurant chains, and so forth. Generally, lease terms are from 10 to 15 years and account for contractual rent escalation over time.
With a portfolio like this, investors can enjoy a stable, long-term passive income and potentially achieve capital appreciation on the properties that are being leased out, which means they can be sold for significantly more than they were purchased for. Having long-term tenants in place also reduces management concerns like filling vacancies, tenant improvement costs, and leasing fees.
However, there are always risks involved with investing and triple net lease investment properties are no different. Businesses can run into hard times and default on their lease, just like an individual leaseholder.
Even if they do not fully default, they might not be able to hold up their end of the deal entirely and may neglect to take care of the property or fail to make required payments – again, that’s why it’s always a good idea to have them make net payments to you and then pay the bills yourself to ensure timeliness and payment in full.
In order to invest in triple lease investment offerings, investors must be accredited and have a net worth of at least $1 million, excluding the value of their primary residence or $200,000 in income. Investors who do not meet these qualifications can still participate by investing in real estate investment trusts (REITs) that specifically focus on triple net lease properties in their portfolios.
Popular Types of Net Leases
While triple net leases are generally considered low-risk for landlords (primarily determined by the credit of the tenant), there are also other net lease options with varying degrees of risks that may be more suitable for different landlords and tenants based on their individual situations. Let’s take a look at some different types of net leases.
Double Net Lease
Double net leases are quite popular in commercial rentals. In this type of agreement, the tenant pays rent as well as the property taxes and the insurance premiums, while the landlord is responsible for all maintenance and repair costs.
Similar to a single net lease, many landlords prefer to have these additional payments made directly to them so that they can handle the payment of taxes and insurance premiums. Often, the landlord’s name is on the tax documents and insurance policy, so they are ultimately on the hook if a tenant forgets to pay the bills.
In many large commercial rental properties, a landlord will have multiple tenants who lease spaces of varying sizes in the same building. In this case, each tenant will be responsible for their proportionate amount of the taxes and insurance premiums based on what percent of the total building they occupy.
Gross Lease – Typical Business Lease
A gross lease allows tenants to pay a flat rent fee each month that includes all the costs associated with the lease: taxes, insurance, and utilities. These types of leases are more common in commercial real estate rentals than in residential agreements, because it can be more difficult to judge what a residential tenant might use in terms of utilities on a monthly basis. Landlords will calculate the flat fee based on the cost of rent, standard expected utility usage, and other common, expected expenses.
Landlords and tenants can also negotiate the terms of a gross lease to include things like janitorial and landscape services, or exclude utilities which the tenant will then pay directly. For some tenants, this type of lease is desirable because it will cost the same every month. This allows for more precise budgeting and allows tenants with limited resources to minimize variable costs while maximizing profits.
However, tenants may end up paying more overall with a gross lease than with a net lease that allows them to pay the exact amount due each month rather than an estimation that is typically higher than necessary to protect the landlord.
Landlords stand to gain a bit of extra money each month from a gross lease, assuming they have calculated the flat fee correctly and no serious maintenance issues arise. However, if something catastrophic were to happen to the building that was not covered by insurance, the landlord could be facing a large repair bill that is their responsibility.
Absolute Net Lease & Single Net Leases
Some property owners use an absolute net lease (also called a bondable lease), which cannot be terminated before its expiration date and does not allow the rent amount to be changed. An absolute net lease dictates that tenants are responsible for all the expenses of a triple net, in addition to the maintenance category which also includes structural, roof maintenance, and repairs – items that are often not included in a typical triple net lease.
Single net leases stipulate that the tenant pays rent as well as the property taxes. These types of leases are less common. Instead, most landlords will choose to do a standard lease where the tenant only pays rent, but the rental amount will include the property tax amount. This way, the landlord can pay the property taxes and be sure that they are paid in full and on time to avoid fees and penalties instead of hoping that the tenant remembers to take care of it.
Less Popular Types of Net Leases
These net leases are less popular than Gross, Double Net, and Triple Net Lease, but are still an option for investors. This guide won’t go in-depth with these; however, if you wish to learn more about these net leases or the more popular leases, feel free to contact our specialist at TFS.
Why Hire a Triple Net Lease Specialist?
First and foremost, it’s a good idea to hire a triple net lease specialist to draw up your lease agreement. This ensures that the agreement is customized to your specific scenario, contains all of the inclusions and exclusions that you and your tenant have agreed upon, and is legally binding and will hold up in court if any problems arise or your tenant fails to abide by the terms of the agreement.
The average investor may not speak fluent ‘legalese,’ and that’s where we at TFS Properties come in – we’ll make sure that your lease agreement is ironclad and explain all the ins and outs to both you and your tenant to help ensure a successful long-term lease relationship.
Additionally, a triple net lease specialist can be extremely helpful if you are considering making your first triple net lease property investment, as they can walk you through the process and answer any questions along the way. It never hurts to have someone with experience in your corner when you are investing large amounts of money.
Our Top Priority
At TFS Properties, Inc., our top priority is protecting our clients’ investment portfolios and offering sound advice and investment strategies. We specialize in triple net lease investment properties as well as other high-income rental properties and §1031 exchanges.
We also have a TFS investor network, where you can find other investors who are interested in §1031 exchanges, which can allow you to swap out your currently owned rental properties for triple net lease properties. Our team has over 30 years of experience working in this niche area and our goal is to provide top-quality investment experience to all of our clients while also ensuring that they achieve the maximum value of each rental property.
Finding You the Perfect Off-Market Properties
One of our specialties is finding off-market investment properties for our clients. In today’s seller’s market, it can be extremely difficult (nearly impossible, in fact) to find investment properties for sale that are reasonably priced and offer high cash flow and cap rates. Our properties are often sourced directly from developers, just recently built, and/or are newly leased. These off-market properties generally have long-term leases in place and include credit-quality tenants such as government entities, healthcare facilities, etc..
With access to markets like these, we can present you with an array of available investment property options that are sure to meet your needs and investment goals.
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