Property Management
NNN Leases; Evaluating The Pros & Cons For Success
Triple net leases come with advantages and risks for both landlords as well as tenants. For example, landlords who rent to stellar long-term tenants can receive a reliable source of passive income, free from operating costs. However, long-term leases can have rent increase caps, which may hinder raising the rent to match market rates. This decreases future income.
| NNN Landlord Pros | NNN Landlord Cons |
| It can be a reliable passive income source | Long-term leases may hinder market rent increases |
| Fewer overhead costs from traditional CRE investment properties | If tenants default or leave, there could be hefty vacancy costs while securing a new tenant |
| Tenants are responsible for property maintenance and expenses. If operating costs increase, this is on the tenant, putting more money in the landlord’s pocket | If they leave, tenants may not maintain the property, causing high repair expenses |
| Landlords build equity while tenants operate the property and pay the bills | When a lease ends, floor plans may need to be reconfigured for new tenants, adding high costs |
| Leases can be transferable to a new investor. With investor-grade tenants, this can make the package more desirable when selling | Tenants without a stellar credit rating can pose financial risk |
NNN tenants can benefit from having control over renovations, allowing them to customize the space to meet their needs and tastes. However, a downside is that they have higher monthly costs than if they were in a single lease with maintenance and repairs covered by the landlord.
| NNN Tenant Pros | NNN Tenant Cons |
| Tenants may have complete control over capital improvements and customizing the space | If multiple tenants are in the building and one leaves or doesn’t do their part, it could increase expenses for other tenants |
| Tenants have some control over which vendors they choose for utilities, repairs, and maintenance. This power to choose can help keep costs manageable | Higher monthly costs for maintenance, repairs, taxes, and operating expenses than a single lease |
| NNNs usually are long-term leases of 10 or 15, providing location security and reducing the risk of hefty rent increases | Property tax increases and inflation can affect the tenant’s bottom line |
| Tenants can use their increased operating costs obligations to negotiate a lower rent | Tenants may have business experience but not have property management experience. If they outsource management, this adds to operating costs |
| Tenants may be able to claim property tax benefits and request caps on tax and insurance increases in their lease | Tenant can be held liable for slip and fall and other injuries |
Alternatives to a NNN
In this deep dive, we answered, “What is a triple net lease?” While triple net leases can be a great source of passive real estate investing and income, investors who don’t have a lot of capital, experience, or resources to buy a NNN investment property may want to start with something smaller such as real estate investment trusts (REITs), crowdfunding, or turnkey properties.
Let’s look at alternatives to triple net leases for landlords and tenants.
- REITs: Paper assets like stocks made up of portfolios of investment properties across various sectors. REITs are a great source of passive income, but they come with risks, so read the prospectus and do your due diligence.
- Real estate crowdfunding/syndication: Investors pool resources to fund real estate investment projects. The investment term for larger projects can last one to five years or more.
- Turnkey properties: Turnkey properties are rent-ready and may come with tenants and property management services in place.
- Traditional leases and investment properties: These include full-service or gross leases where the tenants pay rent, and the landlord covers taxes, property insurance, utilities, repairs, and maintenance.
Frequently Asked Questions (FAQs)
Can you depreciate a triple net lease?
Yes, landlords can depreciate a NNN property. However, only buildings are depreciable. The land it sits on does not depreciate. The straight-line depreciation on a commercial NNN property is 39 years. The tenant cannot depreciate the property but has depreciable property operating expenses such as rent, utilities, and repairs.
What is a $25 NNN?
A $25 triple net lease is when the landlord charges a base rent of $25 per square foot in addition to the rest of the property’s operating expenses. For example, a landlord charges $25/sf (per sq foot) on a 4,800 sf building. The total annual rent is $120,000 ($4,800 * $25), which means the monthly rent is $10,000 ($120,000 / 12 months). The tenant would then pay the monthly rent, in addition to other expenses. It’s a good option when the market rent is at or above $25 per square foot. You may also encounter other dollar amount NNNs where the rent is advertised per sq. ft.
Why would someone agree to a NNN?
A tenant would agree to a triple net lease because the rent for these properties can be lower than non-NNN counterparts, especially in newer properties that don’t need extensive repairs. Investors like NNNs because of the opportunity for long-term quality tenants and a steady stream of passive income with minimal hands-on requirements.
Summary
A NNN is an investment property that offers passive to near-passive income for the investor, and a long-term lease for the tenant. Both parties benefit but also face inherent risks. Landlords can keep expenses lower because they don’t carry the property operating costs, but they risk challenges in finding new tenants if vacancies arise. Tenants have more control over how they remodel the space but carry higher costs with property expenses. Overall, a triple net lease can be an incredible asset for investment portfolios.
