Triple Net Leases in Industrial Real Estate
Triple net leases are playing an increasingly important role in industrial real estate. Find out the upsides and downsides of this hands-off lease structure.
Triple net leases, also known as NNN leases, have gained popularity in recent years. They can be a great tool for investors looking to utilize commercial real estate as a passive investment. This type of lease, also referred to as a net-net-net lease, passes nearly all property expenses to the tenant, reducing a landlord’s expenses.
Because the tenant must pay more property expenses, triple net lease rates tend to be far lower than most other types. Full-service leases, or agreements anywhere between the two — single net and double net leases, for example — build in many of these costs.
What Expenses Do Tenants Pay in a NNN Lease?
In a traditional, full-service commercial lease, tenants only pay base rent and utilities. Triple net leases pass on significantly more costs. These expenses fall into three categories, or "nets":
Property taxes
Building maintenance
Property insurance
What is a triple net lease in industrial real estate?
A triple net lease in industrial real estate is a lease structure that stipulates that the tenant is responsible for paying for insurance, property tax and common area maintenance (CAM) expenses along with the rent. Triple net leases are sometimes abbreviated to NNN in a property listing. This type of lease not only reduces the financial burden but also transfers the financial risks from the landlord to the tenant. The tenant usually pays with one check (or one transaction) that is broken into two portions. The payment is typically divided into the base rent portion and the NNN portion. Source 1 and Source 2.
What are the advantages and disadvantages of a triple net lease?
The advantages of a triple net lease are that tenants generally have more freedom to make alterations and customize space without having to make the substantial capital investment of purchasing a property outright. Tenants may also be able to leverage the added financial responsibility to negotiate lower rents. The addition of property taxes to the borrower’s expenses may even lead to some tax benefits for the tenant. NNN leases also tend to come with protections against tax and insurance increases with the inclusion of caps placed on certain values.
As far as landlords are concerned, triple net leases are a low-risk and reliable source of income that have few overhead costs. The typical tenant in a triple net lease structure is a long-term occupant looking to invest more into its space. Many of the burdens of a landlord are also removed, as most triple net lease scenarios don't even require landlord input in regards to the daily management of the property — the NNN structure places almost all responsibilities directly on the tenant.
The drawbacks of a triple net lease are that tenants face higher monthly costs as opposed to those in double or single net lease structures. Furthermore, since tenants become responsible for taxes, this puts them on the hook for any tax-related liabilities such as fines and penalties. For landlords, triple net leases certainly reduce overhead costs — but there is a risk of reduced long-term earnings. Earning caps, which are commonly found in many triple net lease agreements, prevent a landlord from increasing rent prices beyond a set point. This can result in a loss on future earnings if property values rise. Even though most triple-net tenants are heavily vetted, the risk of a default still exists — and vacancies can cause additional cash flow issues for investors who would face costs that tenants normally pay. Additionally, in some cases landlords may still be responsible for the roof and structure of the property, which can be quite costly should repairs be necessary.
What are the common terms of a triple net lease?
A triple net lease typically stipulates that the tenant is responsible for paying for insurance, property tax and common area maintenance (CAM) expenses along with the rent. The lease terms may be between 10 and 15 years with a predetermined escalating rent. The tenant usually pays with one check (or one transaction) that is broken into two portions. The payment is typically divided into the base rent portion and the NNN portion. (Source 1, Source 2)
What are the tax implications of a triple net lease?
The addition of property taxes to the borrower’s expenses may even lead to some tax benefits for the tenant. NNN leases also tend to come with protections against tax and insurance increases with the inclusion of caps placed on certain values.
For tenants, triple net leases generally provide more freedom to make alterations and customize space without having to make the substantial capital investment of purchasing a property outright. Tenants may also be able to leverage the added financial responsibility to negotiate lower rents.
What are the risks associated with a triple net lease?
The main risk associated with a triple net lease is the higher monthly costs for tenants as opposed to those in double or single net lease structures. Furthermore, since tenants become responsible for taxes, this puts them on the hook for any tax-related liabilities such as fines and penalties. For landlords, there is a risk of reduced long-term earnings due to earning caps, which are commonly found in many triple net lease agreements. Additionally, in some cases landlords may still be responsible for the roof and structure of the property, which can be quite costly should repairs be necessary. Lastly, there is the risk of a tenant default, which can cause additional cash flow issues for investors who would face costs that tenants normally pay. Source and Source
What are the best practices for negotiating a triple net lease?
The best practices for negotiating a triple net lease include understanding the tenant's needs and the landlord's expectations, researching the market to determine a fair rent, and understanding the tax implications of the lease. It is also important to consider the length of the lease, the tenant's ability to make alterations to the space, and the tenant's ability to leverage the added financial responsibility to negotiate lower rents.
For tenants, it is important to understand the landlord's expectations and to negotiate a fair rent. It is also important to consider the length of the lease, the tenant's ability to make alterations to the space, and the tenant's ability to leverage the added financial responsibility to negotiate lower rents. Additionally, tenants should research the market to determine a fair rent and understand the tax implications of the lease.
For landlords, it is important to understand the tenant's needs and to negotiate a fair rent. It is also important to consider the length of the lease, the tenant's ability to make alterations to the space, and the tenant's ability to leverage the added financial responsibility to negotiate lower rents. Additionally, landlords should research the market to determine a fair rent and understand the tax implications of the lease.
Sources:
While tenants pay maintenance costs, this would not usually include major capital expenditures. The landlord generally pays for improvements to a property, such as replacing an HVAC system or repairing a roof. Note that some NNN leases may include major repair costs in full or in part.
Advantages of Triple Net Leases
The clear benefit of a triple net lease to an investor is the stabilization of income from a property. In a full-service lease, a landlord’s annual net operating income will fluctuate based on changes in property taxation and insurance, not to mention unplanned maintenance issues. These can be costly and difficult to predict.
In a NNN lease, tenants pay these costs. As a result, investors can accurately assess financial yields on a property — similar to a bond investment. The only cost not covered by a tenant is vacancy. In other words, so as long as a building is full, your investment approach can generally be very hands off.
Another major selling point for a triple net lease is the lack of hands-on management it requires from an investor. Many investors with these industrial assets don’t have property management responsibilities. Even if a professional third-party management company operates the property, the costs are generally covered by a tenant.
Disadvantages of Triple Net Leases
One of the main downsides to a triple net lease is a result of one of its advantages: the lack of hands-on management. For active industrial investors, NNN leases may not be a good idea, because a landlord's involvement on-site is limited.
Another negative ties to vacancy. Triple net leases are typically for terms of 10 to 15 years. Once that term is up, those costs borne by the previous tenant become yours to pay. If an investor is not prepared for this increase in vacancy-related expenses, this can be difficult to navigate.
Finally, while it may be easy to find a tenant for a new property, many companies looking to occupy a building under a NNN lease need specialized space. Triple net leases are particularly common for large, build-to-suit developments. Finding a new tenant can be a challenge, as the needs of the original tenant may not match those of another. The landlord will be on the hook to reconfigure that space to be marketable — and that can be expensive.