Commercial landlords often use a triple net lease (NNN) when renting space to a tenant. A triple net lease has advantages and disadvantages for the landlord and tenant. It is easy to understand and manage for the property owner, but the lessee has greater control. Also, investors should understand the concept and meaning because real estate investment trusts (REITs) typically utilize triple-net leases. These trusts are known as net lease REITs.
Other lease types are single net, double net, gross, and percentage.
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Meaning of a Triple Net Lease
Most commercial leases are five to ten years long, and some are longer. Because of inflation, operating costs will rise during this time. Additionally, tenants often must modify their space as their requirements change. Hence, landlords like to pass to their tenants as much of the annual cost as possible.
A triple net lease means the tenant pays for all operating expenses, including building maintenance, insurance, and real estate taxes. These three expenses are in addition to rent and utilities. However, the base rent is often lower because the tenant is responsible for rising operating expenses.
In general, most of the risk is transferred to the tenant, but the tenant does not have the risk of buying real estate. Instead, the tenant can use their capital for the business. This type of commercial real estate lease is often referred to as a turnkey property.
Other Commercial Lease Types
In a single net lease, the lessee pays property taxes; in a double net lease, the building insurance is also included. In a percentage lease, the tenant pays base rent and a percentage of the monthly revenue as operating expenses.
How a Triple Net Lease Works
A triple net lease consists of the base rent per square foot. The rent often has an escalator or is indexed to inflation and the base rent rises annually after a fixed period.
Also, the lease includes direct costs of operating the space, like utilities, and a proportional share of the property taxes and insurance. In addition, the tenant is responsible for the interior improvements, maintenance, and a percentage of the common areas.
Example of Triple Net Lease
| Item | Annual Expense |
|---|---|
| Base rent (3,000 sq. ft at $25 per sq. ft.) | $750,000 |
| Recoverable expenses from tenant | $30,000 |
| Operating expenses | $225,000 |
| Property taxes | $30,000 |
| Insurance | $16,000 |
| Total annual cost | $1,051,000 |
| Monthly Payment | $87,583.33 |
Pros and Cons of Triple Net Leases
Both the tenant and the landlord have advantages and disadvantages for triple net leases.
Advantages
The base rent is usually lower for the tenant because they are responsible for all other operating expenses. Consequently, the tenant controls the property’s maintenance and appearance, which is advantageous if the landlord is disinterested. Also, the tenant can improve the property to match a specific look of the brand. In addition, the tenant can select the insurance carrier and dispute property tax issues. Lastly, the tenant does not have to buy a property. Instead, they can focus their effort and capital on their business.
For the landlord, a triple net lease is a consistent source of income over many years. Next, management responsibilities are reduced because the tenant assumes more of the operating costs. Another primary advantage is it protects the lessor against rising operating costs like higher utility bills, property taxes, and insurance. The length of a commercial real estate lease makes this a significant risk. However, landlords must generally maintain some items like roofs, HVAC, and parking.
Disadvantages
The tenant assumes more operational risk because of the long leases. Property taxes, insurance, utilities, and maintenance will probably increase yearly. If projections are underestimated, costs can quickly rise more than expected. Additionally, overhead costs are higher.
The main disadvantage for the landlord is the tenant may not have the financial ability to pay a triple net lease. Competition for quality tenants is fierce. A poor tenant with high credit risk will leave the landlord with vacant property. However, many national retailers, restaurants, and banks utilize triple net leases.
Final Thoughts
A triple net lease is one of several commercial lease types. Both landlords and tenants can benefit, but there are also some disadvantages. More of the risk is transferred to the tenant from the property owners. However, the tenant does not have to purchase a property and may receive a lower base rent. A commercial property owner collects a passive income stream.
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Prakash Kolli is the founder of the Dividend Power site. He is a self-taught investor, analyst, and writer on dividend growth stocks and financial independence. His writings can be found on Seeking Alpha, InvestorPlace, Business Insider, Nasdaq, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial sites. In addition, he is part of the Portfolio Insight and Sure Dividend teams. He was recently in the top 1.0% and 100 (73 out of over 13,450) financial bloggers, as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.
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