Triple Net Lease (NNN): Explanation & Value To Investors
A triple net lease is a type of lease used in commercial real estate that provides tenants with a low base rent but requires them to pay their share of the property’s operating expenses, insurance & taxes, and improvements and repairs in addition. By passing the operating expenses directly to tenants, property investors avoid the risk of having expenses escalate while rent remains stable.
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Triple Net Lease (NNN) Meaning
Some businesses own the property they use for their business, but many prefer to lease some or all of their space so they can instead use their capital to invest in their businesses. That opens the door for investors to own commercial real estate properties throughout the country that can generate tax-advantaged income from stable, long-term tenants.
Commercial real estate leases tend to be a lot longer than residential leases (typically 5-10 years rather than 1-3 years). During these longer leases, the expenses of owning and managing commercial properties can rise substantially. In addition, as businesses grow, they often need to make changes to their space to accommodate more workers, new business lines, new technologies, etc. For these reasons, investors who own commercial properties prefer to structure their lease arrangements in such a way as to pass these expenses to the tenants.
This results in most commercial leases being offered as a fixed amount per square foot that is ‘net’ of certain expenses that the tenant must also pay.
The triple net lease is thus designed to minimize the risk to investors of unforeseen expenses or expenses that increase over time.
Note: Investors are still generally responsible for outside maintenance and repair such as roof work or parking areas.
How a Triple Net Lease Works
In a triple net lease, a commercial tenant is charged the following:
- A base rent per square foot for the space occupied: may include rent escalations over time, move-in concessions, or rent that is tied to an index such as inflation
- A share of the rent for any relevant common area: such as lobbies
- Direct operating expenses attributable to the tenant: such as utilities
- A share of non-operating expenses: such as taxes and insurance
- A share of recurring interior repairs or modifications
Calculating a Triple Net Lease
Triple net leases will typically provide a reasonably predictable cash flow of base rents to investors, but they must also plan for exterior maintenance costs that can be expected to come up periodically, such as roof maintenance, parking area resurfacing, or HVAC maintenance.
The tenant with a triple net lease must consider the changes in utility usage that they may require during the lease term and any anticipated rate increases from the utility providers. They must also project possible changes in the configuration of their space that may result from the growth of their businesses.
Residential vs. Commercial NNN Lease
Triple net leases are common among commercial leases due to the length of the leases and the unpredictable nature of business tenants’ needs. Investors who own commercial properties commonly utilize triple net leases to provide more predictable cash flows and to protect themselves against unforeseen or escalating property expenses.
Residential leases are shorter, so property owners can build in expenses to the base rent more effectively, keeping it simple for renters, and then raise the base rent if necessary when terms expire to keep up with rising operating costs. Residential leases are typically single net leases or gross leases that charge a fixed rent and allow the tenant to secure utilities at their own cost. Space modifications in residential leasing are usually not permitted.
Commercial Real Estate Example
Below is a hypothetical example of a triple net lease for the ABC Wholesale Center:
- Rentable space: 150,000 square feet
- Tenancy: Single tenant
- Term: 10-year triple net
- Tenant responsibilities: Water, electric, trash removal
Terms | Annual amount | |
Base rent | $9 per square foot | $1,350,000 |
Recoverable expenses from tenant | $1.10 per square foot | $165,000 |
Operating expenses | $380,000 per year | $380,000 |
Property taxes | $46,000 per year | $46,000 |
Insurance | $17,000 per year | $17,000 |
Total rent annually | $1,958,000 | |
Monthly payment | $163,167 + utilities |
Triple vs. Single & Double Net Leases
- Single net lease: the tenant pays rent for their space plus specified direct operating expenses (such as their own electrical use).
- Double net lease: the tenant pays rent plus direct operating expenses and is also charged a proportion of non-operating expenses (such as insurance and taxes) that are “passed through” as well.
- Triple net lease: the tenant pays rent plus direct operating and proportional non-operating expenses. In addition, the tenant is charged for certain recurring expenses associated with maintaining the interior of the space (such as repairs or space reconfiguration).
Pros & Cons of an NNN Lease for Investors
Pros
- Lessens risk of unforeseen expenses
- Protects against rising operating costs
- Protects against tenants who require modifications often
Cons
- May deter some commercial tenants
- May underestimate the effect of inflation on operating expenses
- May reduce the growth opportunity of a REIT
Investing in Triple Net Lease REITs
Triple net leases are favorable to investors with regard to both stabilizing and maximizing income from commercial property investments. Often the higher-yielding REITs are those with net leases.
However, stable income is just one of many qualities that determine the attractiveness or success of an investment in REITs. Other qualities include:
- Growth opportunity
- Income growth opportunity
- Liquidity
- Leverage ratio
- Safety
As such, investors who prefer yield may want to focus on REITs with net leases, but investors who look for growth should broaden their search to consider some of the factors mentioned above.
Bottom Line
Triple net leases push the responsibility for operating and non-operating expenses onto tenants, thereby offering commercial real estate owners and investors protection from escalating operating expenses and other unforeseen expenses associated with maintaining commercial properties. This tends to enhance the income yield and stability of commercial real estate investments such as REITs.
FAQs
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Comments (2)
I am not aware of a universal form for identifying charges added to a tenant's rent. Since it is between landlord and tenant and pursuant to the appropriate lease agreement, it should not need to be filed with any gov't entity and would be unique to each tenant-landlord relationship. The important thing is to identify the specific charges and it's a good idea to provide copies of the bills they came from for the tenant's record. The consequence of not providing the necessary information (and in a timely manner) to the tenant is a potential disagreement that could hold up a rent payment, or worse, lead to a complaint or legal action by a tenant who believes they were charged inappropriately. Timely and specific info to the tenant will keep the cash flowing smoothly.