The different types of leases in the world of commercial real estate investment can be confusing. There are net leases and gross leases. There are single net and double net leases. But which type should you choose and when? And what is a triple net lease?
Simply put, in exchange for lower rent and the freedom to customize their spaces, some types of leases ask tenants to contribute to the expense of property maintenance and insurance rather than leaving it up to landlords.
This type of arrangement is the core of a triple net lease, and it can be beneficial for both parties under certain circumstances. Read on to learn when, how and why you might use a triple net lease.
Triple Net Leases vs. Single Net and Double Net Leases
In a net lease, the rent collected is ‘net’ after expenses are passed on to tenants to be paid. This structure allows for potentially lower rent than what would be charged under a ‘gross lease’.
Types of net leases include:
Single Net Lease
The tenant pays only property taxes. The landlord covers insurance and maintenance costs.
Double Net Lease
The tenant is responsible for property taxes and insurance. The landlord handles maintenance expenses.
Triple Net Lease
The tenant is responsible for all three types of expenses.
The choice between these lease types depends on the specific needs and preferences of the parties. Single net and double net leases are good for property owners who want more control over certain aspects of the property. Triple net leases work well when both parties want to share the financial and operational responsibilities.
Understanding Triple Net Leases
What is a triple net lease made of? Aside from the base rent, a triple net lease includes three main components or ‘nets’:
- Property taxes – the taxes levied on the property
- Insurance premiums – for property and liability coverage
- Maintenance costs – repairs and upkeep expenses associated with the property
A triple net lease is often abbreviated in writing as ‘NNN lease’.
In a triple net lease, it is the tenant’s responsibility to ensure that the property remains well-maintained and complies with local regulations.
Triple net leases are particularly common in commercial real estate, especially for office buildings and industrial facilities. In certain situations, it is a win-win for both sides:
- Cutting operating expenses
- Having a steady stream of predictable revenues
- Paying lower base rent
- Having more control over building operations
How to Calculate a Triple Net Lease
Calculating a triple net lease is straightforward.
First, determine the monthly base rent, which is the agreed-upon fixed amount paid by the tenant. Next, add the property taxes and divide the amount by twelve to get the monthly tax payment.
Then, estimate the annual operating expenses. These include insurance, maintenance, utilities, and other costs. Divide this number by twelve to determine the monthly operating expense payment. Finally, add the base rent, property taxes, and operating expenses to get the total monthly lease payment.
Total Monthly Lease Payment = (Base Rent / 12) + (Property Taxes / 12) + (Insurance Costs / 12) + (Maintenance Expenses / 12)
Base rent: $2,000 per month
Property taxes: $6,000 per year
Operating expenses: Insurance costs: $12,000 per year
Maintenance: $2,400 per year
Total Monthly Rent = (2,000) + (6,000 / 12) + (12,000 / 12) + (2,400 / 12)
= $2,000 + $500 + $1,000 + $200
Advantages of Triple Net Leases
Triple net leases offer several benefits for property owners:
- They provide predictable revenues. Since the tenant takes care of the property expenses, it reduces the owner's financial risk.
- Owners can cut their involvement in property management and maintenance. Those responsibilities fall primarily to the tenant.
- Triple net leases can attract long-term tenants who are invested in the property's success. This means they are more likely to take care of it.
Triple net leases can also have advantages for tenants:
- By assuming responsibility for property expenses, tenants can negotiate lower base rent. This can lead to cost savings over time.
- Tenants also have more control over building operations. It allows them to tailor the property to their specific needs and preferences.
Disadvantages of Triple Net Leases
Despite the potential advantages, there are also certain disadvantages to triple net leases. For property owners, the main concern is having less control over the property.
This lack of control can lead to concerns about property neglect or inadequate management practices. If a tenant fails to keep up their end of the bargain, the property owner may still be responsible for the expenses.
On the other hand, tenants may face the unpredictability of costs. Fluctuating property taxes, insurance premiums, and maintenance expenses can make it harder to budget effectively. The responsibility for property maintenance can also be burdensome and may require extra resources.
When a Triple Net Lease is the Right Choice
What is a triple net lease useful for?
Often, it’s the best choice for businesses with stable operations and a long-term commitment to a specific location, such as restaurants, national retail chains, and large corporations.
These businesses typically have the resources to manage property expenses efficiently.
Businesses that need a high degree of control over their premises, such as those requiring specific modifications, facilities, or equipment, may also prefer triple net leases.
Investing in Triple Net Leases
Investors interested in triple net leases can benefit from a reliable and predictable income stream. However, investing in individual properties may require substantial capital. Investors may also need expertise in commercial real estate.
An alternative approach is to invest in Real Estate Investment Trusts (REITs). REITs are a common vehicle for investing in triple net leases. REITs pool capital from multiple investors to purchase and manage a portfolio of properties, including properties with triple net leases.
This arrangement allows individual investors to gain exposure to the commercial real estate market without having to directly own or manage the properties.
What is a Triple Net Lease? Final Thoughts
Triple net leases can provide many advantages. These include predictable revenues for property owners and potentially lower base rent for tenants who are willing to assume a substantial portion of the financial responsibility associated with owning and operating a property.
However, these leases also come with potential disadvantages. Property owners have less control over their property, while tenants face the challenge of unpredictable costs.
Understanding the nuances of triple net leases can help businesses and investors to make better and more informed decisions. They can then align their decisions with specific needs and objectives, and achieve CRE success.