What You Should Know About The Triple Net (NNN) Lease

The NNN Lease, often just called the triple net lease, is a common lease structure used in commercial real estate. Despite the popularity of the NNN lease, the triple net lease structure is still commonly misunderstood by many commercial real estate professionals. In this article we’ll take a deep dive into the NNN lease, dispel some common misconceptions about the triple net lease, and then finally we’ll tie it all together with a clear and concise example.

What is a Triple Net (NNN) Lease?

First of all, what exactly is a triple net, or NNN, lease? A triple net (NNN) lease is defined as a lease structure where the tenant is responsible for paying all operating expenses associated with a property. The triple net or NNN lease is considered a “turnkey” investment since the landlord is not responsible for paying any operating expenses. With that said, in order to fully understand the NNN lease you must first understand the spectrum of commercial real estate leases.

The Spectrum of Commercial Real Estate Leases

All commercial real estate leases fall somewhere along a spectrum with absolute net leases on one end and absolute gross leases on the other end. Most leases fall somewhere in the middle and are considered to be a hybrid lease.

Commercial real estate net lease spectrum

When most people talk about a triple net or NNN lease, they are usually thinking about an absolute net lease. However, just because a lease is called or labelled an NNN lease, does not mean it’s actually an absolute net lease. Often a lease will be called a “triple net lease” for convenience when in fact it is not.

For example, when a building is brand new the tenant may indeed be responsible for funding replacements such as the roof or HVAC systems as they wear out over time. However, on older buildings a lease can often be called triple net, but actually require the landlord to fund these capital expenditures over time, rather than the tenant.

The most important thing to remember when working with commercial real estate leases is to ALWAYS read the lease. The only way to truly understand the terms and conditions of a lease is to actually read the lease. Simple labels like triple net, full service, or modified gross, which are commonly used by brokers and landlords, will often conflict with the actual terms of the lease.

What the NNN Lease Does Not Include

Even if your lease is a true absolute net lease, a common misconception is that even a true absolute net lease covers ALL expenses associated with a property, which is not always the case. While a true absolute NNN lease with a strong tenant can be thought of as a turnkey commercial property from the landlord or investor’s perspective, even an absolute net lease has some expenses that won’t be covered by the tenant(s).

For example, it’s rare for an NNN lease to cover the accounting costs charged by the landlords CPA or legal costs charged by the landlord’s attorneys when drafting or reviewing documents. While these costs are usually small relative to the purchase price of a property, they are nonetheless not typically covered in a standard “NNN lease”.

Triple Net Lease Investment Risks

A common misconception with triple net lease investments is that they are almost risk-free. While triple net investments do offer several advantages, there are still several risks that should be taken into consideration. The primary advantages of triple net lease investments are that you get a predictable revenue stream due to the long-term leases and pass-throughs in place, and you also get a relatively hassle-free investment due to the low management requirements.

While these are compelling advantages, triple net leases also do come with several inherent risks. First, because most triple net lease investments are for single-tenant properties, tenant credit risk is important to understand. For example, not many today doubt the strength of a triple net Walgreens investment since the lease is guaranteed by the parent company, which is publicly traded and financially strong. On the other hand, it is very possible for financial strong and publicly traded tenant to fall out of favor over the term of the lease and ultimately go bankrupt. Since single tenant triple net properties are either 0% vacant or 100% vacant, this should be taken into consideration.

Another risk to consider is the risk of re-leasing. A lot of triple net investment properties are sold towards the end of a longer term lease, shifting the risk of re-leasing the property to the new owner. If the new owner does not have this skillset or a strong team to handle this, then this could present considerable tenant rollover risk.

Assessing Tenant Credit Risk in a Triple Net Lease

One important component to take into account when analyzing a triple net lease investment property is understanding the credit risk of the actual tenant(s). After all, a lease is only as strong as the tenant behind it, so analyzing the financial statements of the tenant on the other side of the NNN lease is critical in understanding downside risk.

Many single tenant triple net lease deals involve publicly traded companies such as Starbucks, Walgreens, or Arby’s. In this case it’s easy to pull up credit ratings on the companies bond issues and to also read stock analyst reports.

For private companies credit analysis requires some more effort, but analyzing financial statements and trends to better understand credit risk is a worthwhile endeavor. For these situations, here’s a primer on better understanding tenant credit analysis.

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Triple Net Lease Example

Let’s take an example to see how a proforma is structured with a triple net lease in place. Suppose we have the following cash flows for a sample investment property:

NNN Lease Example No Reimbursements

The above proforma includes no expense reimbursements from the tenant. In other words, the above proforma assumes all of the leases are absolute gross leases, where the landlord pays all of the expenses for the property. Now, let’s take a look at how the proforma changes when the tenant reimburses the landlord for all of the property’s expenses:

NNN Lease Example

As you can see on the second proforma, the triple net lease in place provides additional reimbursement income that cancels out all of the operating expenses. To be fair, a triple net lease rate will typically be significantly lower than an equivalent gross lease rate for the same property, which would make the bottom line cash flows under a gross lease and a net lease much closer together than in the above example.

However, what the NNN lease ultimately achieves is that it shifts the responsibility, and therefore the risk, of paying the operating expenses from the landlord to the tenant. For example, if property taxes increase one particular year at an unusually high rate, then the landlord’s bottom line cash flow will be protected under an NNN lease and the tenant will be the one responsible for bearing this increased expense. The above shows how a proforma would be structured with these reimbursements in place.

Conclusion

The NNN lease, often just called the “triple net lease” is a popular lease structure in commercial real estate. In this article we defined the triple net lease in the context of the overall spectrum of all commercial real estate leases. We also discussed some common misconceptions about the NNN lease, reviewed some of the major risks associated with triple net lease investment properties, and finally we walked through how a triple net lease proforma is structured.

 

  • Knowing about triple net lease is necessary as it plays an important role in real estate investment. I am glad that you have posted it here with a brief knowledge.

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  • Brad

    Great article! Your point about always reading the lease should be bolded, highlighted, and stamped on an investor’s forehead if needed! As you mentioned, leases have a huge impact on value and many newer investors can overlook that aspect. For beginners, here is an infographic that can be helpful to understand triple net investments.
    http://nnncap.com/understanding-triple-net-lease-properties

    If anyone else has some resources they recommend, I’m all ears.

    • Grilles

      I find it terrifying that anyone would even consider buying an investment property without understanding every provision of the lease(s).

      Then again, people take out mortgages (that they can’t afford) without ever reading that document, either.

  • Dom Reidman

    further evidence that NNN is horrible deal for tenants. This would explain the empty commercial buildings I see everywhere!

    • Grilles

      NNNs have very little to do with market vacancy. And by the way, if you sign a gross lease, you’re still paying those expenses in many cases.

      • sam

        There is a lot on nonsense on this thread but you spoke the truth.

    • Kuljo Ungarzhe

      If NNN, and semi-NNN leases are bad for the tenant, then why do the largest retailers in the world do them – and nothing else? It seems counter-intuitive, until you consider their macro-economics; cash-flow, tax considerations, stockholder demands, etc. Here’s an explanation I recently found;

      “With no mortgage or other indebtedness to be carried as debt on the tenant’s balance sheet, the book value of the company’s assets is effectively understated – enhancing the company’s Return on Assets (ROA). The rent is fully deductible over the lease term, making the tenant’s after-tax cost less than with alternative forms of asset-based financing.”

      I’d bet that WalMart, Walgreen’s, McWalnald’s, etc. might do a good job _also_ being in the business of owning land, but any successful massive corporation has long since learned “‘a cobbler should stick to his last’ – better to do one thing extraordinarily well, than many things badly”. Being an NNN tenant lets them concentrate their business resources on french fries, flu shots and floppy hats. Think about it; why does Wal-Mart sublet to banks and Subways? Because they don’t want to go into a new line of business, when they believe they do their existing one better. Owning property (particularly on their scale) would virtually put them in the real estate business. These are large, publicly held corporations. In other words, they’re owned by skittish stockholders who bought into them with the implied covenant that they do only what they seem to do best. Stock holders are most skittish about uncertainty. Being in both retail and real-estate doubles the uncertainty. Using financial resources for two very different modalities might even border on commingling of funds.

      If you don’t go to State Farm for a burger, and you don’t get your car repaired at Wells Fargo, you don’t want Bed Bath and Beyond being in the real estate business.

      If a large retailer has to buy their own land, it’s a significant chunk of change that doesn’t return for years, or even decades, if ever. That’s the antithesis of cash-flow oriented entity. Retail is, more than anything else, all about the cash-flow.

      If a large retailer has to, for whatever reason, close a location, they just wait out the lease, rather than have to hassle with selling the property. What, then, would they do with capital gains considerations of the proceeds? They’re not in the real estate business, so a 1031 exchange would be even more of a hassle than leaseholders who probably only do that line of business.

      • sam

        NNN are bad for small business tenants not the trillionaire Walmarts of the world

        • Grilles

          That statement exhibits the lack of understanding of commercial real estate. Taxes, insurance, and common-area maintenance are being passed through to tenants no matter how you label the rate. If I charge you a gross rent but it’s higher than the NNN rent, do you feel better about it because of what it’s called?

          If you’re paying a cheap rent and everything is included, you’re going to get what you’re paying for.

      • Grilles

        You’re generalizing WAY too much about retailers and real estate. Yes, one strategy is to rent the majority of their locations. Another is to build more wealth in real estate holdings. McDonald’s is one of the biggest real estate empires in the world and they prefer to stay that way. WalMart rents from itself. Costco owns nearly 700 warehouses. And I’m not sure what you’re getting at with co-mingling funds.

    • Patty Flores

      We got screwed with triple net …our property manager sent us a bill saying that they did an audit for 2014 2015 and you owe us and he raised our triple net 330 a month giving us a week notice…oh yea due in 10 days 4300.00 …some of the business he wants triple depending on the square feet ..one of the business said that his going
      loose his business …and my lease is up next month but i dint have the $$ to move to start over…i’m screwed

      • sam

        How is it possible to have a bill for arrears of 2014 and 2015, you have a lease all the terms of the lease must be adhered to by the Landlord and the Tenant.
        The lease specifies the bumps in rent or other costs and should have been known to you and your attorney before you signed the lease.
        If your lease is over and you can’t afford it then leave
        There is not enough information here but something does not sound correct.

    • sam

      yup

  • Andrew Bermudez

    Great discussion. While I do not agree that NNN deals are horrible for tenants, I do think that tenants should be aware of the total dollar amount they will be paying after adding Triple Net NNN expenses, etc. I wrote a lengthy example of this so that tenants can understand NNN leases and compare them to FSG and MG leases before signing a lease: http://www.getdigsy.com/blog/commercial-real-estate/what-the-heck-does-nnn-mean/

    • Daggsy

      I actually was looking for an answer to a different question, but this is what google spit out for me. My question is WHY would a person buy a commercial property for triple the market value in a poor town? And possibly from a relative handing down a real estate investing business? Case in point – small area with disproportionately high number of low income families – not terribly well educated but low crime. Tourism economy. Summer feast, Winter famine. Building sold in 2007 for about 60K, tax assessed for about 84K, comparable building in area valued at about 130K, sold in 2013 for 320K possibly to the son of the person who bought it for 60K. I started to smell something fishy on this, but do not know enough to properly judge. The area IS building up with new hotel, LONG overdue, but skeptical as to whether the tourism will actually support these new businesses. My interest came as a result of the latest tenant going OUT of business – and just before the holiday season when they would have been VERY busy. The location is perfect for a business I do and the cost is not an issue, but time dealing with any weird control hassles would be. When I called to ask the owner if the space was available and how much, I got a secretary who practically demanded my entire marketing plan and tried to rent me an office upstairs or another building entirely with ZERO knowledge of my business. I called to get the scoop on maybe renting it, not to have somebody assess my business and place it where THEY want it. But that is typical for the area. I would rather buy the building for an inflated price than have a meddling person who may lack integrity on the owner end of my lease. What say ye?

  • Daggsy

    I see an advantage. Many landlords do horrible upgrades or maintenance that affects operating costs by the tenant. I have used this fact to my benefit as a residential tenant as well. First of all, buying the property would be preferable to leasing – and digital business is better for me than “Brick and Mortar” – the stand up location has to be pretty sweet and beneficial to the digital end in order for it to be worth having at all. I have actually paid to replace old systems of utilities and recovered the cost within 2 months – that gives an over all savings on utilities over the landlord’s preference of keeping out dated HVAC. I have successfully negotiated to split the costs of these upgrades as well – in order to have total say in what the replacements are and how I acquire them – then have the building owner pay for professional installation – NO handy man paid in beer.

  • David

    Great read thanks for the info and the other great input from everyone.

  • Thanks for sharing this article about how triple net lease work. Looking forward to read much article you shared. Keep it up. Cheers!

  • laurie

    Looking at a property that is a NNN with a Grease Monkey tenant. Lease is only 3 years. Renewable every three years. This seems strange… why so short? A red flag?