3 Things You Should Know About NNN Expenses

Triple net lease real estate is popular for investors who want to add a low-risk, low-touch property to their portfolio that generates consistent monthly revenue for many years.

Triple net leases are typically used for larger and more complex structures, i.e., a strip center or a chain store such as 7-Eleven or McDonald’s. These properties with leases to large single tenants such as national restaurant chains are extremely popular with investors because they provide turn-key investments. The properties tend to have more complicated leases as the tenant is responsible for rent and utilities, along with all operating costs, which include three main categories (net-net-net) types of financial responsibilities typically included and outlined in the contract:

Commercial Real Estate Taxes & Property Taxes
Insurance Premiums
Maintenance, Repairs and Upkeep. This can include several expenses such as HVAC, landscaping and lawn maintenance, exterior maintenance, parking garages and lots, snow removal and signage.

Typical lease terms are usually 10 to 15 years, including contractual rent escalation.

Triple net leases also include other elements, such as a tenant improvement (TI) allowance, an encouragement offered by property owners to convince tenants to sign a lease. The property owner will also give the tenant a specific amount per square foot to complete renovations on their office, retail, or industrial space. The tenant can also utilize the improvement allowances to cover expenses such as paint, flooring, and electrical issues.

Free rent is another inducement property owners include on long-term leases. Typically, the owner provides a few months of free rent at the start of the lease. When you lease a triple net, the free rent is only extended for the base rent, and the tenant pays operating expenses.

Providing an example of how a triple net lease works, may be helpful: A company owns a 15,000-square-foot building with individual spaces for lease, common areas, and bathrooms: The company spends $120,000 per year on property taxes and insurance, and common area maintenance (CAM). To lease a 1,000-square-foot space in the building, the property owner charges $500 for monthly rent. The property owner also adds up the expense of taxes, insurance, and CAM, totaling $8.00 per square foot per year. In this case, the tenant would have to pay $667 per month for their share of insurance, taxes, and CAM (1,000 square feet divided by $8 and then by 12 for the monthly amount).

Sometimes the commercial lease for a space is advertised at $12/PSF, or $12 per square foot for the base rent, and NNN expenses will be added to that figure, including upkeep of common areas such as parking lots and hallways.

But each deal is as unique as the property itself, so it’s essential to know these three aspects of NNN expenses (from the standpoint of an investor and a tenant) to ensure you choose the best investment for your portfolio.

1. The Majority of NNN Expenses Typically Fall Under Tenant Responsibility

In a triple net lease, the tenant will assume responsibility for every aspect of the property that is outlined in the deal. They are responsible for paying annual taxes, fund repairs or upgrades to keep the building in good working order for their business and cover insurance premiums and claims as required. All of these things can be built into their business expenses and considered costs of doing business.

While NNN leases are beneficial to investors, they also offer tenants an array of advantages, including:

An Established Business Location
A Long-Lasting Footprint
Good Traffic and Proximal Anchor Tenants

To secure a real estate triple net lease, a tenant must have an exceptional credit profile and a proven track record of success in its industry. Tenants are vetted beforehand to help minimize risk and ensure that the tenant is prepared to enter a long-term agreement such as an NNN lease.

Triple net leases can be signed by a wide range of tenants, but they are often used by companies identified in the industry as “credit” tenants. These tenants earn this recognition because their size and financial strength have earned an investment grade assessment by a major credit rating firm (i.e., Fitch, Moody’s, or Standard & Poor’s). This designation means that credit tenants have a minimal risk of defaulting on their lease payments, even in a recession. Examples of credit tenants include CVS, Walgreens, Starbucks, Dollar General and major restaurant chains.

2. Property Owners Can Greatly Benefit From an NNN Lease (But May Also Be Responsible For a Portion of NNN Expenses)

When purchasing a triple net property, an investor typically finances all or a portion of the building’s cost, and then uses rental payments to pay off the financed portion (all while keeping a monthly income stream coming in through the excess of the rent charged versus their monthly loan payment on the property). However, depending on the details negotiated in the NNN lease, a property owner may be at least partially responsible for several expenses, such as structural repairs, insurance, or utilities.

By passing on a few or all of the operating expenses and taxes to the renter, property owners can reduce the impact of market fluctuations and hikes in taxes that can occur over the lease’s term. Triple-net leases also offer property owners some other key advantages, like:

Long-Term, Trusted Tenants Who Are Invested in Success
Little to No Management, Oversight, “Triple Net Landlord Duties” or Property Expenses
Investment Stability
Equity Building
Asset Flexibility

Often, investors will hang on to a triple-net property and use it as an equity builder for at least five years, and then sell the property when the market peaks, the population spikes, or when they are ready to tap that equity for their next investment.

3. NNN Expenses in a Triple Net Lease Are Unique to Each Property

One constant in triple-net real estate is that each NNN lease is unique. Frequently, when an investor purchases a triple-net property, there is already a tenant agreement that outlines all the specifics of the deal. The deal includes clauses that outline the tenant’s and the property owner’s exact financial responsibilities. By investing in a property with an existing triple-net lease in place, you inherit the terms of that deal as written.

This means that you should pay close attention to every detail of the existing lease before deciding to purchase the property. This is important so that you have advance knowledge of responsibilities for insurance premiums or major structural repair costs (which are often distributed between landlord and tenant or are the property owner’s responsibility ).

What is a NNN Investment?

As discussed above, NNN leases are net leases in which the tenant consents to cover property tax, property insurance, and maintenance costs on top of the monthly base rent. This arrangement helps to make properties with these types of leases an excellent investment.

They are desirable investments because properties with a triple net lease can produce long-term income for you while at the same time, providing stability and flexibility. These properties are uncomplicated to own and operate, making them attractive and secure investments. They are even compared to owning bonds because they can be a source of steady and predictable returns.

Another plus is that tenants are often franchises of a major company such as McDonald’s or Taco Bell, which means they are creditworthy and financially stable. Since tenants generally sign long-term leases, it reduces the possibility of having to find a new tenant, as could be the case with shorter-term leases.

Using the 1031 and 1033 Tax-Deferred Exchange Code, you can utilize capital gains to your benefit with your triple net investment. If the value of investment property rises and you choose to sell it, you can then circumvent taxes on the gains by immediately placing your profit into a new property. This enables you to buy larger and better properties and hopefully boost your income. In the process. Thus, you can generate a profit without paying as much in taxes or delay the tax bill.

Also, many investors choose triple net lease investors because they do not have to worry about the day-to-day management of owning a property. Tenants pay for their own maintenance, insurance, and taxes and thus taking care of the repairs and expenses associated with commercial properties. For the landlord or investor, the triple net lease allows him to concentrate on his primary business rather than property management expenses and issues.

The leases on triple net lease properties can typically be transferred. That allows the property owner or investor to sell his or her interest in the property, even if a lease is in place and the property is occupied. As the property owner, you will be able to move on with your investment strategy when it’s the right time for you and not have to worry about having to wait to structure a sale when the term of the lease ends.

Before investing in a triple net lease property. Investors must be accredited and have a minimum net worth of $1 million (not including the appraised value of their primary residence or annual income of $200,000, or $300, for joint filers).

Triple Net Lease Risks

Before purchasing a triple net lease property, potential investors still need to perform due diligence and carefully examine the property, even if it has a credit tenant. Therefore, investors must weigh the advantages and disadvantages of a triple net lease, along with resolving identified risks, before committing to an investment. There are a few risks to study in a gross lease:

Triple net leased properties are typically leased to one tenant, and thus are either completely occupied or 0% leased. This can be a critical concern if the lease nears the end of the lease term and there is doubt if the tenant plans to renew or move out. If the tenant decides to leave, the space must then be released at the current market rate, which may be more or less than the lease rate.
Another risk with having just one occupant, the space’s configuration is tailored for unique use, such as a McDonald’s or Starbucks. As a result, it could be Should a tenant decide to vacate the property, it can be challenging and/or costly to renovate the property for another type of tenant. For example, a triple net leased property’s tenant was a Taco Bell. It may be tough to reconfigure a non-restaurant tenant like a bank. This can reduce the number of tenants who desire the space, and the property could be vacant for a significant amount of time.
A triple net lease’s long terms can be a plus, as we discussed earlier, but it could also be a risk. That’s because the market’s lease rates when a lease expires could be much lower than the original lease rate. As a result, the new tenant may obtain a lower lease rate, which could lead to negative cash flow for the owner.
Potential investors must carefully research the tenant’s credit rating. If the tenant is not a credit tenant, the owner must be vigilant that the tenant may experience financial difficulties and have trouble paying their rent. If this occurs, the cost of evicting the client can be steep, and it may not be easy to release the property at the same rent.

Sands Investment Group is the fastest growing net lease investment company in America, with over 3,000 transactions in 48 states (worth $5.9 billion) since 2010. Our company is composed of distinguished experts in the space who fully understand the advantages of net lease real estate, and can advise you on how your net lease deals should be structured (as well as help you navigate existing net leases on properties you may have an interest in). Our client-focused approach, extensive connections, and marketing expertise are just a few of the ways we’re leading the net lease industry.

Want to learn more? Contact an expert today by calling 844.4.SIG.NNN or sending us an email at info@SIGnnn.com.