NNN Property Investments: What You Should Know

NNN Property Investments
Understanding Asset Types

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As a real estate investor considering your investment options, you may have encountered triple-net lease (NNN) properties. NNN investment properties include a lease agreement that places most of the financial responsibility of managing a property on the tenant rather than the property owner.

A triple-net lease provides property owners with unique benefits and risks. Understanding how these leases operate and the potential advantages and disadvantages of investing is crucial when considering adding a NNN property to your portfolio. Researching the fundamental aspects of NNN investment enables you to make an informed decision.

What Is a NNN Property?

A NNN property is a property for which the lease agreement specifies that the tenant must pay all of the property’s expenses, including real estate taxes, insurance, and maintenance. The term “triple-net lease” comes from the fact that the lease on a NNN property requires the tenant to pay those three property expenses. The tenant in a triple-net lease must also pay standard rent and utilities.

In simplified lease agreements, the landlord is responsible for paying some or all of the above property expenses. NNN leases are common with commercial properties like retail spaces, offices, and industrial buildings.

How a NNN Lease Works

A NNN lease works by shifting more responsibility to tenants than in other lease agreement structures. A net lease in commercial real estate is an agreement where the tenant will pay some or all of the property’s maintenance costs, taxes, and fees. Different kinds of net leases divide the property’s costs between the tenant and property owner differently.

NNN leased investment properties place the burden of paying insurance, real estate taxes, and property maintenance costs squarely on the tenant for the lease’s term. By agreeing to pay for these expenses, tenants assume more financial responsibility for the property’s upkeep and gain more control over the maintenance and operational responsibilities of the property.

Triple-net investment properties can also enable tenants to avoid being overcharged for utilities, taxes, or building insurance, which the landlord might tack on to their rent. Because the landlord is free of the obligation to pay these property upkeep costs, they typically lower the rental payments for tenants.

What Are the Responsibilities Under a NNN Lease?

Each party’s responsibilities in a NNN lease commercial investment are rigidly defined. Each party must meet its obligations as outlined in the lease agreement or face potential consequences like legal action. Here is a brief overview of the responsibilities described in a triple-net lease:

Landlord

Landlords are responsible for collecting rent from tenants on time each month.

Landlords have fewer responsibilities in a NNN lease agreement, making triple-net investment properties potentially attractive to investors. Property owners must handle the following obligations for a NNN lease commercial investment:

  • Collecting rent: While tenants pay utilities, insurance, and property taxes directly to the appropriate parties, they still owe rent payments to the property owner. Landlords are responsible for collecting rent from tenants on time each month.
  • Mortgage payments: Property owners must pay the mortgage payments throughout the lease, which rental income will help offset.
  • Inspecting the property for proper maintenance: Landlords want to ensure their properties are in good condition, including the structure and heating, air conditioning, and plumbing systems. Landlords may inspect their buildings periodically to see whether the tenant follows the maintenance contract.
  • Creating a maintenance contract: Landlords may include a maintenance contract in the lease agreement to define the maintenance tasks the tenant must perform, the maintenance timeline, and other expectations.
  • Structural issues: A landlord may still be responsible for covering any structural issues the property experiences, which include capital improvements such as replumbing a building or replacing an entire roof. These expectations should be outlined in the lease agreement. A net lease that places responsibility for the property’s structure on the tenant is called an absolute net lease.

Tenant

Tenants bear a greater share of the financial responsibilities for a property under a NNN lease, including:

  • Rent: Tenants must pay rent by the agreed-upon date each month. Since landlords don’t have to cover the property’s taxes, insurance, and maintenance expenses, rent payments are usually lower.
  • Utilities: Building utilities like electric, gas, and water all fall under the tenant’s list of obligations in a NNN lease. The tenant pays the expenses to their local utility departments.
  • Building insurance: Tenants may also pay for liability insurance if someone is injured on the property. The tenant may also list the property owner on their insurance policy, protecting the owner in case someone is injured.
  • Property taxes: Tenants must pay real estate taxes for the property. If these taxes increase over the lease term, the tenant is still responsible for paying them. However, landlords and tenants may agree to a cap that transfers the additional tax burden to the landlord if it reaches a certain threshold.
  • Maintenance costs: It’s also the tenant’s responsibility to maintain the property by paying for upgrades, renovations, and repairs over the lease term. Maintenance tasks may include landscaping, maintaining the parking lot, and repairing plumbing or HVAC issues.

Triple- vs. Single- and Double-Net Leases

Besides NNN leases, investors may also choose to use a single- or double-net (NN) lease structure. These three lease structures place varying obligations on landlords and tenants and may each be appealing to tenants in certain situations. When deciding what lease structure to use with your investment property, it’s helpful to have single-, double-, and triple-net leases explained to see the differences between each form.

Here are the main ways in which these leases differ:

  • Tenant responsibilities: In a single-net lease, the tenant only pays for property taxes, rent, and utilities. A NN lease adds the obligation of paying insurance premiums. A NNN lease increases the tenant’s responsibility even more by adding maintenance costs. Some tenants may prefer a single-net lease since it places the least responsibility on them as possible within the limits of a net lease.
  • Landlord responsibilities: In a single-net lease agreement, landlords must pay for the property’s insurance and maintenance expenses but not taxes. A double-net lease only requires landlords to pay maintenance costs. Triple-net leases give landlords the least financial responsibility by freeing them from paying taxes, insurance, and maintenance.
  • Lease term: Single- and double-net leases generally have shorter lease terms, while triple-net leases commonly have 10- and 15-year lease terms. This trend is because the property owner in a triple-net lease agreement will be responsible for more expenses if the current tenant leaves. For this reason, fewer tenants may enter into triple-net lease agreements.

Advantages and Disadvantages of Investing in a NNN Property

As with any investment, triple-net investment properties have unique pros and cons that might make them more attractive to certain investors over others. Here are a few of the advantages and disadvantages of a triple-net investment:

Advantages

One of the most significant benefits of NNN lease structures is the reduced financial burden on the investor.

NNN lease commercial investments have several advantages, such as:

One of the most significant benefits of NNN lease structures is the reduced financial burden on the investor. The tenant is responsible for utility costs, maintenance expenses, and tax payments. This lease structure ultimately makes the investment fairly low-risk.

NNN investment properties also lessen the burden of property management on investors. Since the tenant is responsible for managing maintenance, repairs, and paying taxes and insurance, a NNN investment is relatively hands-off for property owners. Instead of managing the property, you can pursue other ventures.

Because the tenants in a NNN lease are typically businesses and corporations, NNN investment properties usually offer longer-term leases for 15 or even 20 years. Companies may prefer this lease structure because it gives them more freedom over managing and paying for the property. This lease structure also benefits you as an investor because it ensures you will receive a consistent, predictable stream of rental income for the duration of the lease.

Lower tenant turnover is one of the benefits of investing in commercial real estate over residential. Since NNN leases often last for many years, you could experience lower tenant turnover than with a single- or double-net lease or a residential real estate investment where tenants are less obligated to remain in the property long-term.

Disadvantages

A NNN lease commercial investment may also bring a few disadvantages, including:

Tenant improvements are improvements a tenant makes to a rented property. Many businesses require specialized interiors and might extensively renovate the property to suit their needs. When their lease term is up, tenants could leave behind a lot of renovation costs before investors can re-lease the property.

If investors cannot raise the rent during the lease’s duration, they may be locked into a fixed rate that’s less than property rates in the area. A NNN lease could then cap the investor’s earning potential for the property. Investors may be able to reduce this risk by building rent escalations into their lease agreements.

Investors could face challenges when looking for reliable tenants willing to sign a triple-net lease. There may be less competition for commercial properties than residential ones. Finding a tenant with a good credit score could also be challenging. The tenant’s creditworthiness is a significant factor in deciding whether to rent to them, as they must be able to manage rent and utility payments on top of business taxes, insurance, and maintenance expenses. This risk motivates investors to look for investment grade tenants.

During periods of economic downturn, commercial properties often see decreased occupancy and late rental payments. Investors have no guarantee that their tenants will be in business for the duration of the lease term. If the tenant goes bankrupt or defaults, the property owner loses their entire source of rental income. Finding a new tenant may also be difficult.

While a NNN lease minimizes the expenses a property owner pays during the lease, they can incur high losses between tenants. When the property is vacant, the rent goes to zero. The owner becomes responsible for taxes, insurance, and maintenance in addition to the utilities and mortgage.

Tips for Investing in a NNN Property

Tips for Investing in a NNN Property

Investors should always do their due diligence in researching a potential NNN lease commercial investment, market trends in the area, and other typical investment concerns. Since the success of a triple-net investment depends on the tenant’s creditworthiness and the lease terms, this investment calls for some unique considerations. Here are a few tips for investing in triple-net investment properties:

1. Check Tenant Creditworthiness

It’s vital to ensure the tenants you consider for your property are creditworthy. Determine the tenant’s investment grade using a standard rating system like the S&P 500 or Moody’s. These rating systems award the ratings of “AAA,” “AA,” “A,” and “BBB” to investment grade businesses, with AAA ratings signaling the highest credit quality. Businesses with a rating of “BB,” “B,” “CCC,” and below are considered to have a low credit quality.

2. Make the Lease Agreement as Specific as Possible

The specificity of your lease agreement is also highly influential in determining the long-term success of your investment. It’s essential to ensure you fully understand the lease agreement before signing. Making the lease terms as specific as possible can help avoid confusion and disagreements. Stipulate whether you will incorporate rent escalation provisions, define which party is responsible for maintaining the property’s structure, and include other details.

3. Calculate Estimated NNN Expenses

Although the tenant is responsible for paying most of the property’s expenses, it can still be helpful for an investor to calculate the estimated total NNN expenses. Doing so helps prospective tenants budget appropriately and reduces the likelihood of contracting with a tenant who cannot afford all the expenses.

To calculate the estimated NNN expenses for a property, add the projected property taxes, insurance expenses, and regular maintenance costs for the year. Divide the sum of these expenses by 12 to get the tenant’s estimated monthly expenditures, excluding rent and utilities.

4. Consider Investing in a REIT or DST

Investing in a real estate investment trust (REIT) or Delaware Statutory Trust (DST) that buys and manages NNN investment properties provides investors with rental income from NNN leased investment properties without management responsibilities. A REIT is an investment trust that pools investors’ funds to purchase and operate income-producing real estate. When you invest in a REIT, you own shares of the REIT rather than properties. With a DST, investors own pro rata interest in the trust and receive distributions from rental income or the sale of the property. 

REITs and DSTs collect rental income that their properties generate and distribute the income to investors. A team of managers handles the operational responsibilities for the properties in REITs and DSTs, relieving investors of the responsibilities associated with that role in a NNN lease.

The steps for how to invest in a REIT vary depending on the REIT’s type. For example, investors can purchase shares of publicly traded REITs on major United States stock exchanges, while they must go through a broker to buy shares of a non-traded REIT. Accredited investors interested in buying shares of private REITs must go through a broker who participates in the REIT’s offering.

Investors can purchase a fractional interest in a DST by working with a registered representative of the DST’s trustee. Many investors choose DSTs over REITs because they enable investors to defer capital gains taxes through a 1031 exchange.

Invest in NNN Properties With 1031 Crowdfunding

Despite their potential risks, NNN investment properties may provide investors with a reliable source of rental income, the stability of long-term tenants, and the benefits of dependable cash flow without the burden of property management. By researching and preparing to minimize their disadvantages, investors can potentially capitalize on the stable cash flow NNN leased investment properties offer.

1031 Crowdfunding is a leading real estate investment platform for alternative investment vehicles focused on tax-deferral plans. We offer our clients a wide selection of vetted NNN properties and other real estate investment opportunities.

Our management team’s over 108 combined years of experience in real estate equips us to assist you in your due diligence as you consider investments. The senior management team also launched over $1.5 billion in direct and indirect real estate investments, including DSTs and publicly registered and non-traded REITs. Register with 1031 Crowdfunding to view our full selection of NNN properties.

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This material does not constitute an offer to sell or a solicitation of an offer to buy any security. An offer can only be made by a prospectus that contains more complete information on risks, management fees and other expenses. This literature must be accompanied by, and read in conjunction with, a prospectus or private placement memorandum to fully understand the implications and risks of the offering of securities to which it relates. As with all investing, investing in private placements is speculative in nature and involves a degree of risk, including loss of your principal. Past performance is not necessarily indicative of future results and forward-looking statements and projections are not guaranteed to achieve the results described and your actual returns may vary significantly. Investments in private placements are illiquid in nature and there may be no secondary market or ability to sell the investment should the need for liquidity arise. This material should not be construed as tax advice and you should consult with your tax advisor as individual tax situations will vary. Securities offered through Capulent, LLC Member FINRA, SIPC.

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