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.
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.
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.
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:
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:
Tenants bear a greater share of the financial responsibilities for a property under a NNN lease, including:
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:
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:
NNN lease commercial investments have several advantages, such as:
Renting commercial properties is one strategy for generating passive income through real estate investment. Renting through a triple-net lease can provide property owners with reliable monthly rental income, barring the tenant’s default or bankruptcy.
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.
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.
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:
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.
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.
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.
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.
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 115 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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