Triple Net Leases: Pros and Cons to Know
Interested in leasing a commercial space? Know your options! A variety of lease structures are available to you, including the triple net or NNN lease.
What Does a Triple Net Lease Mean?
In a triple net lease agreement, landlords charge a lower monthly rent to commercial tenants and in exchange, the tenant is responsible for covering three additional costs—property taxes, building insurance, and common area maintenance.
How a Triple Net Lease Works
This type of lease gets its "triple" name from the three additional expenses tenants are responsible for, while "net" represents the expenses passed through to the tenant beyond base rent. This can happen monthly, quarterly, or on an annual basis based on pro rata share of the space.
Typically based on the property's value, property taxes paid to the local government cover the public cost of servicing the building and surrounding community from infrastructure and fire protection to waste collection. Note that these taxes are separate from any sales or excise taxes tenants may pay due to their type of business.
Common Area Maintenance (CAM)
CAM refers to charges related to the upkeep, repair, and renovation of shared areas of the building like parking lots, lobbies, restrooms, hallways, and elevators.
Building insurance protects against the cost of rebuilding (or repairing) property after unpredictable events arise such as fires, flooding, or storm damage. Plus, it can include liability insurance that covers against on-premise injury claims.
At first glance, this type of lease agreement may appear to favor landlords, but it can also be a compelling option for tenants. Consider that tenants have more control over how the standard of service and how their money is ultimately spent. Plus, the lessee pays less than the market rate for their lease. Whether you’re a commercial business owner or landlord actively seeking to rent a property—a triple net lease is worth your consideration. Now let's explore more triple net lease pros and cons.
The Pros and Cons of Triple Net Leases
Long-term occupancy is a major benefit for landlords who don't need to worry about searching for new tenants due to frequent turnover or vacancy. Particularly single-tenant agreements. A reliable revenue stream is valuable. The typical triple net lease agreement is 5-10 years and can last up to 25 years or more.
Less Landlord Responsibilities
Landlords can enjoy minimal responsibilities around expenses and maintenance because tenants are responsible for the three “nets” in a triple net lease (property taxes, common area maintenance, and building insurance). If you're a landlord with a property manager collecting the rent and managing tenant communication, you're essentially hands-off beyond depositing rent checks! That fact often makes it easier for landlords to buy NNN properties beyond their backyard, since they require less hands-on attention.
Because tenants pay for the three nets, they pay a lower price point for the base lease than a gross lease agreement, making it a beneficial move under the right circumstances.
Landlords Get Consistent Income
Consistent passive income is extremely attractive to landlords looking for a reliable investment. In fact, triple net leases are one of the top-performing types of leases because they're typically guaranteed by tenants with strong credit that stay in place for a long period of time. Triple net leases typically include a fixed rent increase over time as well, which means the property owner can expect profit growth—even under a long lease term.
Leases Are Transferable
Like most commercial real estate investments, triple net leases are transferable between owners, so they can trade hands multiple times. Under this flexible type of agreement, a landlord can sell their interest in a property even if there's a current tenant (the tenant’s contract will be honored and transferred to the new owner). Essentially, this makes it easier for landlords to move on as needed. For example, you can purchase a long-term lease and cash flow it for a few years before flipping it to the next investor. While commercial real estate isn’t the most liquid asset class, it can generally be sold and transferred without delay if you want to cash out or shift capital to a new project.
Limits Overhead Costs
Under the terms of a triple net lease, landlords aren’t responsible for common area maintenance—tenants are. That means lower overhead costs for landlords. Properties with low vacancy rates also make triple net lease compelling for tenants because property taxes, maintenance costs, and building insurance can be divided by fellow tenants. Dividing those expenses out among lessees means tenants pay a smaller prorated amount of ongoing costs while benefiting from a lower monthly base rent.
Leverage in Negotiations
Tenants can utilize the fine points of a triple net lease as a source of leverage in lease negotiations—especially if they're a company with strong credit. You can use your creditworthiness as a bargaining chip to lower the base monthly rate since landlords favor tenants with a proven history of financial responsibility.
More Control Over The Property
Tenants under a triple net lease are empowered with more control over property appearance and upkeep. That's because they don’t have to rely on a property owner to make timely fixes or upgrades. Plus, tenants can also choose which contractors to hire for repairs and renovations. On the other hand, many investors prefer a triple net lease because it protects them from expense increases. Instead, those costs are passed along to the tenants. So, if your property taxes change or common area maintenance goes up due to unexpected factors—tenants are responsible instead of landlords.
Despite the additional costs, businesses that choose to sign a triple net lease can more easily leverage an attractive location to their advantage.
While triple net leases can be an excellent option for landlords and tenants alike, there are also challenges to keep in mind.
Difficulty Finding Tenants
Landlords may experience difficulty finding tenants. Lower base rent might be attractive for tenants, but signing a long-term lease presents risks. So does the idea of having to cover property taxes, common area maintenance, and business insurance. In some cases, landlords would benefit from being able to educate potential tenants on the upside of a triple net lease agreement.
When a commercial lease expires, landlords need to ensure the property is in solid shape for the next tenant. That can mean an investment of time and resources. Consider that the last tenants may have let the property fall into disrepair, especially near the close of their contract when there's less incentive to invest in building maintenance. Ultimately, rollover costs could mean spending significant capital to repair and update the building for the next tenant. For single tenant net leases, properties are often built-out to accommodate their unique needs, so releasing the space to a different business could prove difficult. Consider what elements may need to evolve and factor in potential rollover costs.
Under a triple net lease agreement, all responsibilities of maintaining the property are on the tenant, which can result in significant unforeseen costs. For example, tenants are responsible for property damage caused by natural disasters. Building insurance won't cover everything.
While triple net leases are long-term, there's still the risk of a tenant defaulting, which could result in losses while you work to fill the vacancy. Even a thorough vetting process doesn't completely eliminate the risk associated with vacancy costs.
Landlord Earning Caps
With NNN leases, the landlord passes on the majority of the costs of the property to the tenant. As a result, the base rent the landlord charges is less. Of course, there’s no hard cap on what a landlord can earn on a triple net lease, but since the tenant bears a lot of the costs for upkeep of the property, landlords should expect lower revenue than a more standard lease.
There's inherent danger in the unknown and unexpected—it's difficult to plan for and impossible to prevent. Although triple net leases can offer tenants lower lease payments, unforeseen costs (like any kind of property damage) may greatly increase repairs, maintenance costs, and monthly insurance premiums. Also consider that ongoing expenses in a triple net lease are generally paid directly to the landlord, so tenants are unable to deduct them on their taxes.
Upside Potential Limited
Under a triple net lease there isn’t as great of opportunity for a value-add investor to increase the value and income potential of a commercial property because long-term tenants typically pay fixed based rent. That isn't to say that upside potential is possible (it is!) landlords just have to wait until that lease expires or the tenant moves out to increase rent or make building updates. For investors motivated to secure passive income from a safe investment, limited upside potential isn't necessarily a deterrent. However, for value-add individuals seeking to push yields, a triple net lease may not be the ideal option.
Tenants Maintain Assets They Don't Own
The fact is, property maintenance costs add up and it can be difficult to justify these expenses when the building doesn't belong to you. Since landlords own the asset, they're ultimately more incentivized to keep the property safe and up-to-date, because they own the asset and a well-maintained property increases in value. As a result, tenants are less motivated to maintain the property as long as it's meeting their basic needs.
Tenants Cover More Responsibilities
Tenants are on the hook for more than base rent under the terms of a triple net lease agreement. Unlike a standard lease in which a tenant typically pays a single bill to the landlord, there are three additional responsibilities associated with a NNN (property insurance, common area maintenance, and building insurance—which are all subject to increase. Unknown (or unexpected) costs therefore make it more difficult for businesses to forecast in their operating budget.
Why Would You Want a Triple Net Lease?
Triple net leases can absolutely be a mutually beneficial way to structure a lease. What's important to remember is that both parties consider the pros and cons before reaching an agreement.
If you're a landlord…
A consistent revenue stream, triple net leases benefit landlords because they don't need to consider the headache of frequent tenant turnover. Vacancies are far less common than short-term leases. Expect less hands-on management because any property management costs (property taxes, common area maintenance, and building insurance) are all on the tenant. Ultimately, this longer type of lease structure gives landlords more time and energy to focus on their primary business as well.
If you're a tenant…
A tenant may want a triple net lease because they're empowered to manage property appearance, maintenance.quality, and more. Plus, tenants have direct control over utility costs like water and electricity along with their preferred insurance carrier.
Looking to make your next New York commercial real estate investment?
The triple net lease experts at Verada are available to help you achieve your goals every step of the way. A next-generation commercial platform and brokerage specializing in servicing premium neighborhood retail, we serve as a one-stop shop for commercial real estate landlords and retail tenants. Together we provide all-inclusive services for NYC neighborhood retail with a forward-thinking approach that leverages emerging technologies, content-based marketing, and a deep understanding of the market to better match landlords and tenants.
Rely on Verada to streamline the leasing process so you can better focus on your business. Now here’s what you can expect:
Maximize the visibility of your property by leveraging our platform, social media, digital advertising and marketing, and direct outreach
Procure and vet quality tenants to ensure smooth transactions and long-term retention
Provide ongoing service through the life cycle of your property
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