Why do a NNN lease?
In the world of commercial real estate, the lease agreement is vital to making sure everyone knows who is responsible for what. Leases can be structured any way the landlord and tenant agree on, so why do so many choose to write things out the same way?
While part of it may be familiarity with the terms from past experience, there are some serious advantages for both the tenant and the landlord for choosing to go triple net (NNN). Let’s take a look at these types of leases to see just why they are so popular.
Who pays for what in a NNN lease?
In a NNN lease, the three nets always come from the same three expenses: property taxes, insurance, and common area maintenance or “CAM” for short. These are passed directly on the tenant in what is known as a “pass-through” or “reimbursable expense” according to their usage of the property. You may be thinking “So all I have to do is collect the rent check and be done? Sweet!”, but unfortunately there is just a little more to it than that. Note that these expenses are reimbursed - meaning the landlord is still the one being initially billed for the property taxes, insurance, and maintenance.
Here’s a simple example of how this might play out. Let’s say you own a retail property and a toilet goes out. First, the tenant will call the property manager and let them know what happened. The property manager will get someone to fix it, then send you the bill. At the end of the month you’ll take your tenants base rent, add on whatever the cost to fix the toilet was, and send that number to the tenant as their rent for the month. When you get their check, you’ll pay the bill from your property manager and pocket the base rent.
Property taxes and insurance are passed on the same way, the only difference being where the bills are coming from. Because each of these expenses flows directly to the tenant, as the landlord you get to keep the same amount (the base rent) every month regardless of what happens. You may already be starting to see why a landlord would like this arrangement so let’s head there next.
The Landlord’s Perspective
Say you own a building and there is a major hailstorm coming to your area. Would you rather be up all night worrying about potential property damage and your insurance premium going up, or sleep soundly knowing that everything would be taken care of? Most of us, I’m sure, would prefer the latter. This peace of mind, or stability, is what a NNN lease offers the landlord. A NNN lease, combined with a solid property management team, takes away nearly all the stress of property ownership, freeing up your time and letting you focus on finding new opportunities instead of worrying about fluctuations in property expenses.
The protection of a NNN lease can help out in other areas, as well. Lenders love to see stable recurring income, allowing you to get lower credit rates on projects where your personal credit profile is key. If you’re retired, you now know your exact monthly budget, or, if you’re saving for the down payment on a new property, you now know the exact timeline. Having consistency in your cash flows just makes things simpler.
The Tenant’s Perspective
As a tenant, the cheaper your rent is the more money you can funnel back into your business. In a NNN lease, any reduction in expenses comes back to you directly in the form of a lower addition to your base rent. This means your personal decisions, from turning off the lights when you go home to picking out what landscaping you want, all have a chance to save money for you and your business. This opportunity to lower your monthly cost is what makes NNN leases so attractive to tenants.
It also can provide some protection if you’re renting from a landlord who doesn’t have the best reputation. In a full gross lease not only would you have to pay a higher rate every month, but also the landlord would get to pocket any difference between your payment and their maintenance costs. This means there's a chance you might end up paying more money, for worse service, than if you had signed a NNN lease instead.
Should You Do a NNN Lease?
In commercial real estate, as in most other finance-related industries, the greater the risk the greater the reward. In a NNN lease the landlord gives up the chance of a reward in return for greater stability in their monthly cash flows. The tenant takes on the risk, but also inherits the opportunity for reward if they can find ways to cut costs or run things more efficiently.
Whether or not this type of leasing arrangement will work for you depends on how comfortable you are with taking on risk and your personal strategy towards real estate investment. In any case, make sure that you’re talking through items piece by piece through the leasing process as what will work best will change depending on the specific circumstances and property.
Here’s a closer look at some of the potential downsides you need to consider before investing in a triple net lease property.