What is a triple net lease (NNN) & how to calculate it?

What is a triple net lease (NNN) in real estate?

A triple net lease, or NNN lease, is a specific type of lease used when renting a property. It usually involves commercial real estate. An NNN lease gets its name from the three categories of expenses the lessee must bear. The landlord receives lease rentals “net” of real estate taxes, insurance, and maintenance.

In simple terms, the lessee bears practically all the operating expenses related to the property. Triple net leases are popular with investors because of this. The owner does not need to bother paying property taxes, meeting maintenance costs, or paying property tax insurance. This makes NNN real estate a low-risk passive investment that can provide the owner with a stable monthly return. Additionally, investors gain if the property increases in value.

Triple net leases vs single net leases and double net leases

Commercial real estate owners should be familiar with two other types of similar lease structures. These are the double net lease and the single net lease. The following table will illustrate how each of these three leases differs.

Triple net lease vs double net lease vs single net lease

Type of lease	Expenses borne by the tenant
Single net lease	Property taxes
Double net lease	Property taxes
	Property insurance
Triple net lease	Property taxes
	Property insurance
	Maintenance costs

As you can see, a triple net lease passes on the obligation of making property-related payments to the lessee. Commercial real estate leases of this type can be an attractive option for risk-averse landlords as the burden of operating expenses moves to the tenant.

Components of an NNN lease

At this stage, it could be a good idea to examine more closely the three categories of operating expenses – property taxes, insurance, and maintenance – that the tenants are expected to bear in a triple net lease.

Property taxes

Property taxes are ad valorem taxes paid to the local government authority. The tax calculation is based on the property’s assessed value. These taxes are an essential source of revenue for local governing bodies. In fact, they are the biggest revenue earner for state and local governments. The money collected goes towards payments for fire and emergency medical services, sanitation, roads, and other public services.

Insurance

Insurance is the second category of expense that the tenant is responsible for. Commercial real estate insurance typically provides coverage against losses due to:

• Fire
• Theft
• Damage from floods
• Vandalism

Triple net leases usually allow the tenant to shop for the best rates and select an insurer. This can result in big savings and better claim management in the event of an insurable event.

Maintenance

A triple net lease passes on the responsibility of property maintenance to the tenant. The lessee bears all or sometimes most expenses for keeping the building functional and in optimum condition.

In a commercial real estate lease, the following are some of the expenses that could be classified under maintenance:

• Cleaning
• Electrical work
• Plumbing
• HVAC maintenance

How to calculate a triple net lease

The lease agreement stipulates the triple net lease amount. It is a figure that is negotiated between the landlord and tenant. However, it is important to remember that the expected actual expenses form the basis for the calculation.

Landlords typically arrive at the sum payable monthly by renters by adding the amounts for annual property taxes, the insurance premium for the property, and annual maintenance costs to the base rent. This figure is divided by 12 to arrive at the monthly payment to be made by the tenant.

You should also know that while in triple net leases, the tenant is responsible for paying maintenance expenses, there are some costs that the landlord could continue to bear. For example, the commercial lease agreement may specify that the upkeep of the parking lot or landscaping would be paid directly by the landlord. Some of the other expenditures that could fall within this category are the sums related to the structural elements of the building or the costs for roof maintenance.

Triple net lease example

Here is an example that illustrates the triple net lease calculation. Consider a commercial lease with a base rent of $50 per square foot per year. The annual triple net lease rate is $14 per square foot. The following table shows how much the tenant will pay monthly to rent 2,000 square feet of office space.

Triple net lease calculation

	Annual	Monthly
Base rent per square foot	$50	$4.17
Base rent for 2,000 square feet	$100,000	$8,333
Triple net lease expenses per square foot	$14	$1.17
Triple net lease expenses for 2,000 square feet	$28,000	$2,333
Total lease rate per square foot	$64	$5.34
Total lease rate for 2,000 square feet	$128,000	$10,666

Triple net leases pros and cons

Triple net leases are popular with both landlords and tenants. This section lists their advantages and disadvantages from their respective viewpoints.

Pros of triple net leases

While triple net leases offer advantages to both landlord and tenants, their suitability depends on factors such as property type, location, market conditions, and specific goals and preferences. Here are some specific advantages of triple net leases:

For landlords

• It is an ideal arrangement for landlords who want to adopt a hands-off approach to property ownership. Owners don’t need to get involved in the nitty-gritty of day-to-day management, as the tenant is responsible for paying practically all the operating expenses related to the property.
• The tenant handles maintenance issues. For investors, this can be a big plus. The last thing that absentee landlords want is to have to handle the routine matters related to the property’s upkeep.
• The lease gives the property owner a steady stream of predictable returns. As costs are passed on to the tenant, the possibility of an unpleasant surprise in the form of increased property expenses or insurance premiums is minimized.

For tenants

• As tenants control maintenance, they can tailor the activities related to the property’s upkeep to their standards. This could be especially important for retail real estate and customer-facing businesses.
• Tenants also derive another benefit from handling the maintenance themselves. They can minimize expenses by shopping around for the best rates from vendors.
• When negotiating the lease agreement, the tenant may be able to cap certain costs. For example, the agreement could state that the landlord would be responsible for any insurance premiums or property tax increase beyond a specific limit.

Cons of triple net leases

Triple net leases offer financial benefits and risk-sharing mechanisms, but they also come with potential drawbacks related to limited control, market volatility, negotiation complexity, and property-specific considerations. Here are some of its disadvantages:

For landlords

• Tenants may customize the property to suit their needs. This could make it difficult for the landlord to rent the premises to a new tenant. Refurbishing the property could mean an additional cost for the landlord to bear.
• Premises rented on an NNN basis could have higher vacancy costs as they are harder to fill.
• Triple net leases typically have longer terms. If market rates go up, this could be a disadvantage for landlords, as they would be stuck with lower rents for the duration of the lease.

For tenants

• The responsibility for making property tax payments falls on the tenant. If rates increase or a penalty is imposed, the tenant may be liable to pay the additional amounts.
• Tenants oversee the upkeep of the property and are responsible for making payments related to property tax, insurance, and maintenance. They would need to devote time and energy to these tasks.
• The tenant is responsible for paying maintenance charges. This could have adverse implications. For example, if the property is damaged, the tenant may have to get it repaired, and insurance may not cover the entire cost.

How to invest in triple net leases

When making a triple net lease investment, it is vital to carefully carry out your due diligence. Looking for a real estate broker specializing in triple net lease investments could also be a good idea.

Remember to ensure the tenant you lease your property to is reliable. Look for investment-grade renters with a history of timely lease payments. You should also know that specific categories of properties make suitable triple net lease investments. Some are fast food joints, retail stores, medical and veterinary clinics, and auto part stores.

There is another factor you need to take into consideration. Triple net lease investments are only available to accredited investors. The SEC lays down the criteria investors need to meet. Briefly, the SEC rules state that accredited investors are those who (meeting just one of the conditions listed below is sufficient):

• Have a net worth of more than $1 million. This figure does not include their primary residence.
• Have an annual income of over $200,000 in the two prior years.

The bottom line

Triple net lease properties are an excellent option for investors looking for hassle-free real estate investments. They provide a stable source of income as well as the possibility of capital appreciation. However, investors must be on their guard when selecting a property and a tenant. If they exercise adequate caution, they are more likely to make a safe and rewarding investment.

Modified Date & Time : 22 Apr 2024, 06:55 am