Real estate investors have several commercial lease options when considering a new investment or a replacement property for a 1031 exchange. Net leases are contracts in which the tenant agrees to pay a specified amount for rent and split certain additional expenses with the landlord or property owner. Net lease agreements specify whether the tenant is responsible for costs such as building maintenance and repairs, utilities, property taxes, and insurance. Net leases typically have a longer duration than gross commercial or residential leases, often ranging from three to 10 years.
Single, double, and triple net leases divide each party’s financial responsibilities for the duration of the lease differently. Understanding the differences between these categories of net leases enables investors to make informed decisions about the properties they add to their portfolios.
Single Net Lease
A single net lease, also called a net lease or N lease, is a contract in which the tenant is responsible for paying a pre-established rental rate and a portion or all of the building’s property taxes. A single net lease may include utilities if the landlord adds those expenses to the monthly rent.
Single net leases place the least financial obligation on tenants, as the landlord must continue paying all other operating expenses, including insurance premiums, maintenance and repair costs, and utilities. However, the tenant may be responsible for minor repairs or maintenance tasks as specified in the lease agreement.
Landlords may lower a tenant’s monthly rent to compensate for the additional expense of paying property taxes, which are based on the property’s value. Although a single net lease shifts the burden of paying property taxes to the tenant, some property owners may prefer the payments to pass through them so they can ensure the tenant is paying the correct amount on time. If the tenant misses or makes late property tax payments, the municipality holds the landlord responsible and may enforce fines or place a lien on the property.
Single net leases may be more popular with tenants who want to assume the least amount of responsibility possible within the structure of a net lease. A single net lease can be advantageous for tenants, as they may have lower rent payments compared to other types of commercial leases.
This net lease structure also gives tenants more insight into the amount of property tax they are paying. However, single net leases may be the least common option among landlords, who often prefer to assume a smaller share of the financial burden. Of the three types of net leases, landlords retain the most significant amount of risk with single net leases.
Double Net Lease
In a double net lease, the obligation to pay rent plus property taxes and insurance lies with the tenant. Property insurance could include coverage against physical damage like fires and floods, liability insurance, and title insurance. A double net lease structure places more responsibility on the tenant than a single net lease but less than a triple net lease. The landlord is still responsible for paying all other operating expenses, such as maintenance and utilities. Some landlords call this net lease structure a net-net lease or a NN lease.
Property owners may adjust a tenant’s rental obligation periodically, such as annually, to offset the cost of paying property taxes and insurance, which may change over the years. If a tenant rents a section of a larger property, such as an office building or shopping mall, the landlord might prorate each tenant’s tax and insurance expenses based on the square footage each tenant is renting. As with single net leases, the landlord may include tax and insurance costs in the rent and pay the bills to the municipality and insurance company to avoid fees for late payments.
Double net lease structures only require landlords to pay for the building’s maintenance and repairs. The tenant covers all other expenses. This feature makes double net leases popular with landlords who want to be responsible for less of the building’s costs than with a single net lease. Although this net lease structure passes more risk to the tenant, tenants who want visibility into the taxes and property insurance they pay may find these net leases appealing. However, if tax or insurance rates rise, the tenants are responsible for paying.
Triple Net Lease
A triple net lease, also called a net-net-net lease or NNN lease, requires tenants to pay property taxes, insurance, and maintenance and repairs, on top of their monthly rent and potentially utilities. The difference between double net and triple net leases is significant, as maintenance and repair costs can be unpredictable and substantial. However, the landlord may be responsible for major structural repairs or replacements. Triple net leases place the greatest financial responsibility on the tenant of any net lease structure.
Landlords might reduce the monthly rent to compensate for the tenant’s additional responsibilities. Because of a tenant’s financial obligation in a triple net lease, landlords may prefer to use this net lease structure with tenants renting an entire building long-term, such as for 10 or more years. Landlords and tenants may negotiate scheduled annual rent increases over the lease term to reflect inflation. In addition, a property owner might require the tenant to maintain the property to a specific standard and regularly inspect the building.
Tenants in a triple net lease may be responsible for insurance deductibles, repairs of property damage, and other unexpected costs. Due to these responsibilities, some tenants may prefer to have less financial risk than is involved in a triple net lease. Others might find it appealing that triple net leases provide enhanced visibility into their expenses. A triple net lease may also give tenants more flexibility to renovate the building as their business requires, although with the landlord’s oversight. Triple net leases appeal to landlords who want less financial burden for their property.
How to Calculate a Net Lease
Calculating a net lease requires information that may vary based on the net lease structure and specific lease negotiated. Start by determining how much of the space within the building the tenant is renting. Calculating a net lease is more straightforward if the tenant rents an entire property. If a tenant is only renting a portion of a building, determine their space’s square footage compared to the building’s total square footage.
With the square footage calculated, you can determine the rest of their financial obligation based on their net lease structure. Suppose a landlord is leasing a property to two tenants. Tenant A is leasing 500 square feet for $10,000 a month, and Tenant B is leasing 1,000 square feet for $20,000 per month.
Based on the square footage each tenant is renting, Tenant A will be responsible for one-third of net lease expenses, and Tenant B will be responsible for the remaining two-thirds. Whether the tenants are in single, double, or triple net leases, the property owner will total the costs and divide them between Tenant A and Tenant B by their share of the leased space. A few examples of how the responsibilities in single, double, and triple net leases are divided can help clarify calculating a net lease.
Net Lease Examples
Using scenarios with real numbers that illustrate the division of obligations in different net lease structures may help real estate investors understand how net lease structures work. Consider these examples of single, double, and triple net leases:
Single Net Lease Example
In a single net lease, the tenant is only responsible for monthly rent and property taxes. Suppose the local government collects a $14,400 yearly property tax on a building totaling $1,200 a month. If one tenant rents the entire property, they will be responsible for paying the $1,200 monthly tax.
If Tenant A pays $10,000 monthly rent and Tenant B owes $20,000, divide the monthly property tax between the tenants. In this situation, Tenant A would pay one-third of the property tax, which would be $400. Tenant B would be responsible for $800 a month. In return, the landlord decreases each tenant’s monthly rent by the amount they pay in property taxes. Therefore, Tenant A would pay $9,600 monthly rent, and Tenant B would pay $19,200.
Double Net Lease Example
A double net lease structure requires tenants to bear the burden of paying monthly rent, property taxes, and insurance. Suppose building insurance costs $28,800 annually, which is a monthly charge of $2,400. With one tenant leasing the building, they are responsible for the monthly payment.
Using the same tenants above, Tenant A’s expenses now include $400 a month for property tax and one-third of $2,400 or $800 a month for insurance, totaling $1,200. Tenant B must pay $800 in taxes and two-thirds of $2,400 or $1,600 for insurance, equaling $2,400. The property owner reduces each tenant’s rent to offset expenses, bringing Tenant A’s rent down to $8,800 and Tenant B’s to $17,600.
Triple Net Lease Example
In a triple net lease, the tenant must pay taxes, insurance, and maintenance costs on top of monthly rent. Maintenance and repair costs can be unpredictable, but in this example, Tenant A estimates they will need to pay $1,000 a month for maintenance, and Tenant B expects a cost of $2,000 monthly. When added to these tenants’ other expenses, they now pay $2,200 and $4,400, respectively.
The property owner now charges Tenant A $7,800 monthly for rent and Tenant B $15,600. However, the property owner is satisfied with the triple net lease arrangement. Although their monthly rental income decreased from $30,000 to $23,400, their expenses decreased by $6,600. This leaves a net monthly cost of $0. Since the tenants are now solely responsible for navigating tax increases, insurance premium hikes, and unexpected maintenance costs, the landlord benefits from reduced risk.
Pros and Cons of Net Leases
Different net lease structures may appeal to tenants and landlords in various situations. Real estate investors considering investing in a property must understand the potential advantages and disadvantages of different net lease structures. Here are the main pros and cons of these types of leases:
Single Net Lease
Consider the advantage of a single net lease:
- Reduced landlord risk: Compared to a gross lease, a single net lease reduces some risk for property owners. In a gross lease, the landlord retains the responsibility to pay property taxes, insurance, and maintenance and repair expenses. Landlords in a single net lease must only pay insurance and maintenance expenses.
Single net leases can also carry some disadvantages for landlords:
- Collecting property taxes: Although tenants are financially responsible for paying property taxes in a single net lease, property owners may still want to collect the funds to ensure tenants pay on time. This involves handling additional responsibilities.
- Insurance and maintenance costs: Even though single net leases relieve landlords of being responsible for property taxes, they must still deal with insurance and maintenance costs.
- Ultimate responsibility for the property’s taxes: If a tenant pays property taxes late or incorrectly, the property owner is still responsible for resolving the issue.
Double Net Lease
Landlords may find double net leases appealing because of the following:
- Further reduced landlord risk: Property owners who want to deal with fewer variable costs than in a single net lease may prefer a double net lease structure. In a double net lease, tenants cover property taxes and insurance premiums.
This net lease structure may also bring a few cons:
- Collecting property taxes and insurance premiums: As with single net leases, landlords may collect tenants’ tax and insurance payments and remit them to the municipality and insurance company to prevent late payments, adding more responsibility to the landlord.
- Maintenance costs: Property owners must be prepared to cover building upkeep and repair costs. These expenses could include regular servicing, system replacements, and unanticipated repairs.
Triple Net Lease
Understanding the potential advantages and disadvantages of investing in triple net lease properties helps real estate investors determine whether this net lease structure works for their investment goals. Consider the pros of adding a NNN investment property to your portfolio:
- Lowest risk for landlords: Property owners may find triple net leases appealing because they place the highest risk on the tenant. If taxes, insurance premiums, and maintenance costs rise, the tenant has to pay the higher rates.
- Fewer landlord responsibilities: Tenants in triple net leases often pay taxes and insurance directly instead of through the landlord. The landlord may only need to inspect repairs to ensure they were completed correctly.
- Long-term occupancy: Landlords may find the long-term rental terms accompanying triple net leases appealing because they have guaranteed long-term tenants.
Despite these advantages, NNN investment properties may also have some cons for landlords:
- Tenant improvements (TIs): In a triple net lease, tenants can make building improvements to suit their business needs. Landlords may not have much say over what kinds of improvements are done and will likely have to renovate once the tenant leaves to ensure the space is suitable for a new tenant.
- Rollover costs: Triple net leases are typically long-term because of the level of risk the property owner incurs if a tenant leaves. If a tenant defaults on their lease, the landlord will suddenly have to pay property taxes, insurance, and maintenance costs, all without rental income.
- Restricted earning potential: Although property owners and tenants often negotiate for gradual rental rate increases in a triple net lease, these long-term leases can limit a property owner’s earning potential. Depending on the property and location, market rental rates might be higher than what the tenant is paying in the long run.
Additional Net Lease Considerations
Landlords should keep in mind a few additional considerations before signing a net lease or investing in a property with an existing net lease. Property owners should ensure tenants are clear on their financial responsibilities and understand that their costs could increase because of tax and insurance hikes. It may be helpful to have a professional property inspection on the building before signing any net leases so the property owner and tenant are aware of maintenance costs that could arise.
Real estate investors may also consider some alternatives to net leases. For example, some tenants may prefer a gross lease, in which they are only responsible for a flat rental rate. In this situation, the property owner raises the rent to cover the additional expenses. Tenants may also agree to a modified gross lease. In a modified gross lease, the tenant pays the flat rental rate at the beginning of the lease’s term and gradually pays a proportional cost of the tax, insurance, and maintenance expenses.
Invest in NNN Properties Through 1031 Crowdfunding
Single, double, and triple net leases offer landlords and tenants a range of financial and property management responsibilities. Understanding how net lease structures work and how they might affect property investments can help real estate investors decide whether a net lease is the right decision for their investment goals.
Despite their potential disadvantages, triple net investment properties may provide investors with steady rental income without the burden of property management. 1031 Crowdfunding is a leading real estate investment platform for alternative investment vehicles focused on tax deferral. Our clients can access a wide selection of vetted NNN investment properties and other real estate investment opportunities.
With over $2.2 billion in combined real estate transactions, the management team at 1031 Crowdfunding is equipped with the experience needed to help you navigate your investments. To view our offerings, register with 1031 Crowdfunding today.
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