A triple net lease can be a winner for both a landlord and a tenant, but does it come with disadvantages along the way? These are some of the most important triple net lease pros and cons from both a landlord and tenant perspective.
11 Important Triple Net Lease Pros and Cons
If you are getting into commercial real estate, whether as a buyer or a tenant, you will come across the term Triple Net Lease. Lease agreements are pretty straightforward when it comes to residential properties.
However, there may be variations in the lease term options with commercial real estate.
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Triple net lease is a common concept throughout the United States. Before going through with such a lease, you should know the triple net lease pros and cons both as a landlord and as a tenant.
What is a Triple Net Lease?
A triple net lease is a type of lease where the tenant is responsible for expenses of the property in addition to the gross rent. The expenses that are usually paid by the landlord are to be paid by the tenant till the end of the lease.
- Property taxes that the government collects.
- Property insurance that helps protect the property from unforeseen damage.
- Maintenance costs to maintain and improve the property.
This type of lease is usually appropriate for offices, retail stores, restaurants, and other businesses, such as a gas station. It is often called the Triple N lease or simply NNN lease.
Usually, this lease lasts for ten years. However, some tenants sign up for as long as 25 years from the beginning.
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Even though the tenant is paying taxes and insurance, as well as maintaining the property, it stays in the name of the landlord.
Also, the income that the owner receives is still liable for taxes.
How Does a Triple Net Lease Work
A triple net lease may sound a bit complicated, but it does not have to. It is very popular with commercial real estate investors all over the country.
Just like a normal lease, the tenant would agree to pay a monthly rent for the property based mainly on the value of the property. This could be fixed rent for the entire lease term or have a fixed increase at the end of each year to account for inflation.
This is usually 3% of the initial rent.
In addition to the gross rent, the tenant also agrees to pay the property tax, property insurance, and any other specific or general expenses of the property.
This essentially bars the owner from looking after these affairs. These terms are usually negotiated with the help of a broker.
True Triple Net Lease
The ‘true triple N’ lease or ‘absolute NNN’ lease is considered the most binding of the triple net lease variations. In this type of lease, the tenant is responsible for every expense related to the property whatsoever.
If the property gets damaged, the onus falls on the tenant to rebuild it, whether insurance covers it or not.
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There is another variation termed ‘ground lease.’ This involves the owner renting land to the tenant to build some structures.
However, at the end of the lease agreement, the structure built becomes the property of the landowner.
Now, these costs are not fixed. The taxes may get higher, and insurance premiums may become expensive. Nevertheless, it is the responsibility of the tenant to ensure timely payment of the expenses they have agreed to pay.
Failure to do so results in procedures for eviction of the tenant.
Keep in mind that the property remains under the ownership of the landlord. Even though the tenant is paying the taxes, they are under the name of the owner.
Also, the logistics of these expenses fall on the tenant.
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Pros and Cons of Triple Net Leases
Since there are two parties involved, it is important to know the triple net lease pros and cons from both perspectives i.e., as an owner and as a tenant.
There are advantages and disadvantages to both parties involved.
Tiple Net Lease Pros and Cons for the Landlord
Pros for the Landlord
The single biggest benefit of a triple net lease to the owner is a long-term occupancy of the property with consistent income. Whether you have set a flat rent or a fixed increase rate for the monthly rent, there will be money coming in your pocket. It is a steady income that the owner can use to grow their capital.
Most agreements signed are for upwards of 10 years.
Unlike a traditional lease agreement, the owner is free from all the responsibilities of the property. Whether it is property tax or looking after the physical property, the owner is free from any managerial work.
This hassle-free nature of a true triple N lease makes it a very attractive option for commercial property owners.
See Related: How to Invest in Industrial Real Estate
Owner Can Sell Property With the Lease
The owner is at liberty to sell their property even if there is a tenant with a triple net lease on it. This gives the owner the freedom to get a return on the investment they have made on the property any time they want.
The lease usually transfers to the new owner with the same terms. The tenant does not have to evict the property before or after the sale. The new owner has to abide by the terms agreed on by the previous owner.
However, they still benefit from the income the property gives through this lease.
Rent Income Is Separate From Actual Rent
The monthly gross rent the tenant pays directly to the owner is separate from all the other expenditures of the property the tenant bears. Even though for the tenant, all the expenses related to the property are one, for the owner, it is just rent they are receiving.
This makes it easy for them to maintain their account books. If all the payments, including taxes and maintenance costs, were to go through the owner, it would make the finances of the agreement quite complex.
Cons for the Landlord
This is true that as an owner, you get a steady income from the property in rent. However, this would count as fixed income even with fixed increments. You cannot increase the rent at any point during the lease.
If the property values in the area rise, you cannot benefit from the corresponding rent hikes.
Usually, the triple net lease agreements last for decades.
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The responsibility of taxes, premium, and maintenance costs fall on the tenants, but as an owner, you are liable at the end of the day. If the tenant of the property fails to pay the taxes, it leaves the owner vulnerable.
High Expenses Post Lease
After the lease expires and the tenant does not want to renew it, the owner may be left with heavy expenses before leasing it to another tenant. These agreements last quite long, usually 10 to 25 years. During this time, the property may not remain in the best shape.
It becomes the responsibility of the owner to fix and repair things.
The tenant may not have taken good care of the property or made improvements needed over time, even though it was their responsibility.
Depending on how they used the property, you could be looking at a very high capital expenditure before being able to lease it out again.
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Triple Net Lease Pros and Cons for the Tenant
Pros for the Tenant
In this type of agreement, tenant pays reduced gross rent. Since the tenant is responsible for all other expenses related to the property, the rent is lower.
In comparison, the rent would be higher if the lease did not require the tenant to pay property tax, utilities, and insurance directly.
As a tenant in a triple net lease agreement, you are responsible for maintenance and repair costs as well. This gives more control in your hand in terms of choosing which repairs to complete and what contractors to hire.
The tenant can decide and carry-out necessary improvements to the property that would allow their business to grow and increase their revenue.
Similarly, there is more control over utility expenses. They can manage the utilities and pay the actual costs. As opposed to a high rent rate designed to cover utilities, this ends up saving the tenant money.
Triple net leases are common for properties located in high-value areas with higher traffic and exposure. For instance, commercial properties in the downtown metropolitan area would be up for a triple net lease.
These kinds of areas have very high growth rates.
Businesses can generate high revenues with their presence in such a prime location.
Cons for the Tenant
High Costs & Responsibilities
The very apparent disadvantage to the tenant in a NNN lease is the costs associated with the property that they have to bear no matter what. Unlike the rent of the property, which is pre-decided in the agreement, the costs are not fixed. Tax rates and insurance premiums can increase.
Similarly, maintenance costs would gradually increase with inflation and constant use of the property.
On top of the costs that the tenant has to bear, they also have to go through the hassle of ensuring all these bills are paid on time. It may become difficult to stay within the operating budget.
Property Damage Risks
Since all the responsibilities fall on the shoulders of the tenant, they are also liable for repairs in case of an accident. Whether it is because of a human error or a natural disaster, the tenant has to arrange all repairs.
In some cases, such costs may not be completely covered by insurance.
Also, with serious damage to the property, it may become even more expensive to maintain it to keep the business running.
A tenant may not be able to deduct these maintenance costs of the property from their taxes.
What Does Landlord Pay in Triple Net Lease?
This is a common question that potential tenants ask before going into a triple N lease agreement. While most costs related to the property are borne by the tenant, the actual division of costs depends on the terms of the agreement negotiated by both parties.
The terms differ from one NNN agreement to another. These terms depend on many variables.
In absolute or true triple net leases, the owner usually does not pay anything.
However, some expenses might still be the responsibility of the owner, for example, the extension of the property.
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Is Triple Net Lease a Good Idea?
Now that you have weighed the triple net lease pros and cons from both the perspective of an owner and a tenant, you might ask yourself, is it a good idea to go through with such a lease agreement?
It may appear to be in favor of the owner, but that is not necessarily the case. With the right terms, it can be beneficial for both parties.
For a tenant, there are higher costs and tax inefficiencies, but those can be offset by leveraging your main advantage points.
Commonly, tenants go into a triple net lease agreement solely because of the location of the property. Location can make or break the success of a business. For that reason, they are willing to take the risks involved.
For a landlord, there are more advantages than disadvantages. That said, you can mitigate the risks by negotiating the right terms and properly vetting the potential tenant.
You do not want a tenant defaulting on the lease as that can result in heavy losses and a difficult vacancy to fill.
The truth is, a triple net lease requires complex accounting for both parties to profit from it.
This is why landlords and tenants work with brokers to maintain their interests from the lease agreement.
Conclusion on Triple Net Leases
When going into a triple net lease for a commercial estate, always look around for other options and compare them. In some case, if a landlord is offering a general lease that only requires you to pay monthly rent may be more suitable for your business.
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It really boils down to what your needs are and what you plan to do with the property.
You will find that most owners with properties located in an expensive commercial area with proper zoning offering triple net leases.
It is always a good idea to consult with professionals after doing your homework on the matter.
A real estate broker with extensive knowledge of the properties in your target area can give an objective opinion.