As you consider your lease options for a new real estate investment, you might want to know if a triple net investment is the right choice. Whether you're working with a 1031 exchange or acquiring new properties for commercial leasing, an NNN investment may be an appealing option.
What Is a Triple Net Lease Investment?
In a lease operated through a triple net investment, tenants are responsible for paying rent, property taxes, insurance and professional maintenance for common areas. A "net" is each area the tenant pays. The number of nets depends on the specific agreement.
The appeal of a triple net lease for the tenant is that more responsibility results in greater control over the property's finances. With the combined utility bills, property taxes and insurance payments, the tenant knows they are paying directly for the worth of the property without being overcharged for the price of standard rent.
Other characteristics of a triple net lease could include:
- Real estate investors maintain rights to the property and are responsible for finding a new occupant once the tenant moves out.
- The tenant is usually a business owner renting the space as a business location instead of a residence.
- The lease is often arranged for a long-term period, which could be a profitable feature for the landlord.
- The investor is responsible for preparing the commercial real estate before the tenant agrees to the lease terms. This includes making renovations suitable to the tenant's business practices.
Other ways to structure a lease agreement include a double net lease, single net lease, gross, absolute or bond lease. Below are the most common lease arrangements.
It's possible to set up a different type of lease for your commercial property. Triple net leases could be a good option for commercial real estate investments, but you should also consider other leases as you build an investment portfolio and evaluate your risks. Some of the most common ways to arrange a lease for commercial real estate include a gross lease, single net lease, double net lease, triple net lease and absolute NNN lease.
A gross lease is distinct from a net lease in that it requires the tenant to pay a set fee for the exclusive use of the rental property. The flat fee might include utilities, real estate taxes and insurance. Gross leases are used in the majority of lease agreements for residential properties.
You can modify a gross lease for the tenant's specific preferences, much like how you can add or subtract nets for an N property.
Single Net (N) Lease
Single net leases are uncommon for commercial property owners. A single net means responsibilities are more evenly shared between the tenant and the landlord. In an N lease, the tenant pays for only the rent and the real estate taxes. This option might appeal to tenants who want less involvement in the property.
Double Net (NN) Lease
In an NN lease, the tenant agrees to pay two primary obligations for commercial real estate in addition to rent. The tenant's first obligation is the real estate taxes, and the second is the insurance. The agreed price of rent is usually lower after additional expenses.
As a landlord, you would be responsible for the rental's maintenance costs, including repairs for utility failures. In this arrangement, tenants rely on your financial assistance if damages occur, and they are also protected through an insurance premium that they pay.
Triple Net (NNN) Lease
In a triple net lease, the tenant pays property taxes, insurance and maintenance in addition to the rent. Combining these expenses in the lease allows you to charge a lower cost for rent. Many business leases operate this way, providing affordable rent for the tenant and lower overall maintenance costs for the owner.
This option benefits tenants who want the most control possible over the property without having ownership of the building. If the tenant needs to change locations, they can move without having to sell a commercial building.
Absolute NNN Lease
In an absolute or bondable lease, the tenant pays rent and all of the property's expenses, including any changes or repairs to the structure itself. As the property owner, you would still have rights over the real estate, but all financial obligations would be the tenant's sole responsibility.
An absolute net lease is similar to an NNN lease, but it gives the most responsibility to the tenant, who takes on more risks with this type of lease agreement. The tenant acts as the owner of the building but can change locations if they need or want to.
This type of lease appeals to many larger commercial tenants. Rather than buying a permanent facility, they lease a building in case future changes to the city or the neighborhood impact their consumer market. They can switch locations without having to sell a commercial building, which carries less financial risk.
Benefits of Triple Net Leases In Your Real Estate Portfolio
Triple net investments are popular lease options for investors involved with commercial real estate, but investors who are used to residential leases might be unfamiliar with them. This type of investment property lease is the most commonly selected for commercial and retail properties. Below are several benefits that make triple net leases appealing for your commercial property space:
- Increased financial security: The tenant pays the most important bills for maintaining the property in exchange for a lower rent. This usually results in predictable returns, and it simplifies the process of keeping up with the property's costs. You collect your income directly through the rent payments, whereas with bundled rent, you would have to distribute the tenant's payments multiple ways each month.
- Less professional responsibility: In a triple net lease, the tenant is responsible for financing and operating the facilities. Owning a triple net property is a hands-off experience for you as the landlord. If the tenant is also responsible for maintenance and upkeep, they will hire contractors to come to the property when necessary.
- Lower time commitments: You will have more time to manage multiple properties while under fewer obligations with NNN leases. This makes your work in the commercial real estate investment industry streamlined.
- Stable agreements: You need to find a reliable tenant with an excellent credit rating to justify leasing a triple net property. This is one reason the lease arrangement is particularly stable. Commercial tenants also tend to remain with the property over a long-term period. Triple net lease agreements have higher reliability as a result, with your only major concern being to find another tenant if a business does choose to end their contract agreement with you.
- Gradually higher income: The increased stability of the property results in netting more income from the lease conditions. You will experience these results over a long period of time, and you will be able to include built-in rent increases in your contract terms.
Risks of Triple Net Leases
All investments come with risk factors. Although triple net investment properties generally make good returns over time, there are some risks you should be aware of:
- The property must be business-ready: Tenants want the property to meet their requirements before agreeing to a NNN lease. Their specific requirements will depend on the business's industry and may result in requests for Tenant Improvements (TIs). For example, restaurant owners might require renovations to the interior to include a large kitchen separate from the rest of the building. When you lease the property to a business owner in a different industry, you might also have to undo initial renovations or make new ones.
- Tenants can switch locations: Long-term leases are the norm because the property will hold a vacancy if a tenant chooses not to renew the lease. If the tenant moves their business, you will become responsible for paying the insurance, maintenance fees and property taxes until you secure a new tenant. A long-term lease reduces your risk as the building owner.
- The lease structure could deter some tenants: A triple net lease has the potential to be a great deal for a business owner in need of a rental space, but some opt for a different type of lease altogether. The reason for this is that a tenant might want to avoid paying for emergency damages or large-scale repairs. For extra cautious tenants or those who prefer less responsibility for the property, a lease with fewer nets may be more attractive.
You can minimize these risks by selecting the property and tenant carefully. Research your potential NNN investment property's location, and determine the primary industries of business owners who might be interested in buying. Be prepared to answer questions about the property for curious tenants. Mitigating these factors can lead to a successful real estate investment.
How to Get Started Investing In NNN Leases
Understanding your leasing options is essential when you want to invest in commercial properties, but most information regards residential leases instead of the lease structures available for commercial property owners. Access to 1031 Crowdfunding's options can help make this process easier.
If you're new to NNN investment properties, the first step for getting started involves carefully examining your options.
1. Evaluate the Real Estate
The first step in securing a profitable investment is examining the real estate property. Think about how attractive the location and the building might be for potential business owners. Ask yourself the following questions:
- Is the property in a commercial district? Neighboring businesses will draw traffic to your tenant's location. The cross-over traffic from primary retail areas is a natural way for the tenant's business to thrive without employing any advertising.
- Are competitor businesses in the immediate area? Some tenants looking for a physical location for their small startup might be deterred by a large corporate building offering the same services across the street. Other tenants benefit from competitors, which is why the industry matters. For example, if your tenant sells clothes, they might prefer being surrounded by other fashion retail stores.
- Does the area experience low crime? A prime business location gets the most interest when it has a reputation for safe tourism or local shopping. You will also find that properties in areas considered low crime have a higher real estate value compared to equivalent properties in areas flagged for high crime.
2. Evaluate the Potential Tenants
Before you offer a lease agreement, carefully screen each tenant who applies to rent the location. Avoid offering the property to the first interested party. When deciding on a tenant:
- Get a credit history report for the tenant and the business: Without checking the major reporting agencies, you are unaware of a business's history. Even if it is currently profitable, look at the credit report for red flags.
- Run a background check on the tenant: Regardless of the tenant's industry, a background check can give you key insights into the owner's ethics. Poor ethics could result in fines or legal consequences, which can impact the tenant's ability to pay for the property. You can also be held legally responsible if your tenant breaks the law and there is evidence to suspect you had awareness.
- Collect proof of income: A business owner rarely looks to move into a physical location without having a decently profitable history from operating online or through partnerships. Reviewing proof of a tenant's income can determine their potential sustainability at the property. A potential tenant should possess a significant financial history to confirm their ability to pay rent.
- Collect key financial information directly from the tenant: This includes information about the business and estimated earnings.
3. Evaluate the Lease Agreement
Work out the terms of the lease agreement on your own before presenting to the potential tenant. It's crucial to find a compatible tenant who would agree to the conditions and type of lease you prefer. Ask yourself these questions before making a deal:
- What if the tenant wants to amend one of the lease's conditions? Consider why the tenant might want to amend the lease. If the tenant is otherwise a great fit, consider working out the compromise.
- What if the tenant wants a different lease? If the tenant is inexperienced with NNN leases, they might believe a more familiar type of lease would be better for them. In this case, it might help to explain the differences and how a triple net lease could benefit them.
- What if the tenant wants a shorter leasing period? This could result in a greater risk for the property owner. If the tenant is new to the area, they might just want to make sure they have made a good choice in location.
If the answers to these questions would alter the lease significantly, it's best to choose a different tenant who can meet all criteria.
Learn More About Triple Net Options on 1031 Crowdfunding
If you want to enjoy the many benefits of investing in a triple net lease property, 1031 Crowdfunding is here to simplify the process. We provide all documentation and paperwork online, and when you work with us, you can avoid dealing with NNNs on your own. Work with our experienced managers instead, who handle the day-to-day operations. Register online today to learn more about the triple net options on our website or explore our online real estate marketplace.