You Need to Know These: Net Lease & NNN Lease?

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A net lease and NNN lease are options that can be applicable across many sectors, but knowing the details of each, and when to engage them is key to negotiations and strategies. Knowing what your market demands to maximize your occupancy is also critical to making the most from your commercial real estate investments.

What is a net lease?

Commercial tenants tend to require more control over their leased property than residential tenants, which is where a net lease comes in. With a net lease, a lessee is given significantly more “ownership” over their property as they are responsible for more expenses compared to an all-inclusive “gross lease” where the landlord covers expenses from paid rents.

With a net lease, a tenant pays some of:

• Operating Costs
• Taxes
• Maintanance
• Insurance

A net lease can be expanded or reduced depending on tenant needs, making a net lease a more flexible option for business owners than a traditional gross lease.

Types of net leases

“Net lease” is a blanket term covering multiple types of leases where the lessee assumes some or all of the liability of a property’s expenses by taking responsibility for taxes, maintenance, and insurance. Net leases are divided into 4 categories:

• Single net lease: A tenant assumes control of one of the three main categories of operating expenses: taxes, maintenance, or insurance
• Double net lease: A tenant assumes control of two of the three main categories of operating expenses: taxes, maintenance, or insurance
• Triple net lease (NNN): A tenant assumes control of all three main categories of operating expenses: taxes, maintenance, or insurance
• Absolute net lease: Granting a lessee nearly total responsibility for a property, an absolute net lease covers the three main categories of operating expenses and any major repairs. 

Why a triple net lease (NNN)?

A triple net lease, also known as a net-net-net lease, requires the tenant to cover all 3 major categories of operating expenses: taxes, maintenance, and insurance fees. 

When compared to a single net or gross lease, a triple net lease is more of a turnkey investment for potential commercial property owners. With so much responsibility placed on the tenant, properties with triple net leases already in place are potentially low-risk passive investments.

Triple net leases are most often applicable to single-residency units, as the lease agreement would include utilities and maintenance for the entire building. In some cases, though, multi-tenant buildings may seek a variation of a triple net lease where costs such as insurance, utilities, and maintenance are spread across tenants by a fixed amount.

Pros of a triple net lease

Tenants

• Property Control: Tenants are granted significantly more control over the property with a triple net lease, meaning they can control maintenance and the appearance of a property, a huge bonus for business owners who need to customize their space.
• Rate Negotiating Power: A triple net lease, compared to a gross lease, also gives a tenant more leverage for negotiating lower rents. With so much risk being assumed, a tenant may negotiate rent changes based on upkeep and property improvements made during their lease.

Owners

• Passive Operations: For property owners, a triple net lease provides more consistent revenue and less direct management, as operating costs are to be covered by the tenant, except for major repairs in certain cases. With most of the property management responsibilities placed directly on the tenant, overhead and management is significantly reduced for the property owner.
• Longer Occupancy: Additionally, triple net leases are more attractive for long-term, stable tenants. When a tenant has full control over a property, they are more likely to keep the property for longer. For this reason, large, multinational companies such as Walgreens often opt for long-term triple net leases.

Cons of a triple net lease

Tenants

With a triple net lease, most of the risks are transferred to the tenant. In addition to base rent, tenants must be prepared for out-of-pocket unexpected expenses, including repairs and taxes. 

• Expense Planning: Tenants with a triple net lease may require a more flexible budget to be prepared for these expenses. While many triple net agreements include property owner responsibility for major repairs, the day-to-day maintenance, and minor upkeep can be a major cost.
• Fluctuating Costs: Tenants are also subject to more market fluctuations with a triple net lease compared to a single net or gross lease. As they are on the hook for maintenance, tenants are subject to market fluctuations in the costs of materials and labor, increasing the need for liquidity.

Owners

A triple net lease requires a reliable and trustworthy tenant, which could mean more time between leases. Increased downtime between leases equals less revenue. 

• Loss of Control: During these downtimes, a property owner must seek a financially secure tenant, as much of the operating costs will depend on the tenant. With so much risk transferred to the lessee, property owners lose much control over their property.
• Long-term Rate Lock: While a triple net lease will reduce owner overhead costs, and having a locked in tenant can be a solid asset for stability, long-term earnings could also be negatively impacted as property values rise. Many triple net agreements include an earning cap, reducing the property owner’s ability to raise rent prices above a certain level.

It is also important to note that there is no such thing as a perfect tenant. Even the most thoroughly vetted potential tenant can default, losing the property owner time and money

Summary

The more “net” (single, double, triple), the more responsibility the tenant bears. A NNN lease option can be a winning solution for tenants seeking more control over the property, as well as a hope to negotiate a lower rate as the landlord will not be covering the taxes, insurance, and maintenance, but this comes with a need to plan for those expenses on the tenant’s part. These tenants are usually long-term which can provide some stability to the landlord’s revenue stream.

Each scenario should be evaluated by looking at the tenant’s genuine ability to obligate to a NNN lease vs a Single or Double Net solution while comparing that to the goals of the owner in relation to how active or passive the operational model will be.

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