WHAT IS OR ARE NET, NNN, TRIPLE NET ?
The Secret Sauce for Controlling Costs in Retail Real Estate!
A Triple Net lease (or “NNN” lease) is a real estate lease agreement where the tenant or lessee is responsible for the ongoing expenses of the property, including Real Estate Taxes, Insurance, and Maintenance, in addition to paying the rent and utilities.
The three major ongoing expenses (other than utilities and mortgage payments) related to owning a property can be placed into one of three categories:
• Real Estate Taxes (Property Taxes)
An example of a Gross Lease is the standard lease that residential landlords often use when renting an apartment. An amount of money is paid for rent, and all three categories of expenses listed above remain the landlord’s responsibility. Gross Leases are also found in Office properties and Industrial properties.
Most of the other types of leases are Modified Gross or some form of Net Lease (Retail Real Estate Leases may include a Percentage of sales as rent).
There are three basic types of net leases, defined by how many of the expense items are paid by the tenant. These items include Real Estate Taxes, Maintenance of Common Area (for example parking lot, parking lot lighting, landscaping among other items) and Insurance (Liability Insurance for the Common Areas and Property Insurance for the building (the tenant will also carry its own insurance for contents in its premises and liability inside its premises along with Workers Compensation insurance).
- Net: (or N or Single Net) The tenant pays base rent plus the Real Estate Taxes.
- Net Net: (or NN or Double Net) The tenant pays base rent plus the Real Estate Taxes and Insurance.
- Net Net Net: (or NNN or Triple Net) The tenant pays base rent plus the Real Estate Taxes, Insurance and Maintenance costs.
The words “net and “net-net-net” are often used interchangeably (if not precisely), because it is generally assumed that a net lease is a triple net lease. In fact, wise retail real estate developers and investors will always try to write a triple net lease to minimize expenses and expense inflation risks. This means the tenant will pay rent per square foot on the space, plus a monthly charge for his or her share of the property taxes, insurance and maintenance of the
In general, Triple Net (NNN) leases are most often used for Retail Real Estate including Shopping Centers and freestanding Single Tenant Retail Real Estate buildings, but also can be seen in use for other property types, as well including Low Rise Office Buildings and more and more frequently Industrial Buildings.
Landlords and investors like triple net leases because they create a steady and predictable income stream. As anyone who has owned a single family home or multifamily apartment building will know, property taxes, insurance and maintenance expenses can fluctuate, sometimes dramatically, from year to year. Most of the time expenses increase which reduces the Net Operating Income of your property and decreases the profitability and value of your investment. For example, if you have a very bad winter and snow plowing expenses increase dramatically, the tenant would be responsible for paying all of the costs associated with snow removal and sanding/salting. Likewise, any property taxes and increases would be borne by the tenant (the is especially critical now with excessive government spending and ridiculous public pension ponzi schemes). A Triple Net (NNN) lease will normally have a lower Minimum Rent (or Base Rent) rate than a Gross Lease because the landlord’s risk for expense increases are passed through to the tenant.
By passing these expenses on to the tenant, you the property owner, and your investors (if any) know how much income will be received each month (and year). Retail Real Estate leases are generally signed for long initial periods (5, 10, 20 and even 50 years) so it is important to protect against the risks associated with rising expenses cutting into the rental income originally projected when the lease was signed.
Below are very basic examples of a Gross Lease, Modified Gross Lease and a Triple Net Lease. It is an analysis for a Retail Tenant occupying your 10,000 square foot building on the corner of Main Street and Main Avenue in Megalopolis USA for a ten (10) year lease term. In all three (3) examples the expenses increase at 2% per year (because EXPENSES ALWAYS INCREASE) and the rent stays flat for the entire term.
Gross Lease example:
Modified Gross Lease example:
Triple Net Lease also known as NNN Lease example:
As you can see in the above examples, the Triple Net ( NNN ) lease provides reimbursement income that basically negates the operating expenses and preserves the projected income (and Return) to the investor.
Additionally, even when a Shopping Center lease or Single Tenant Retail Real Estate lease is advertised or sold as a Triple Net lease, it is vitally important to READ THE LEASE! The actual agreement may or may not include the payment of some common Net expenses or may have a cap on how much expenses can increase each year. The common area and maintenance clauses in Triple Net leases usually go into great detail about what expenses are included as and what expenses will are not allowed to be billed back to the tenant So while a Triple Net lease might call for the Real Estate Taxes, Insurance and Maintenance to be paid by the tenant, there are different levels paid for those expenses by each tenant which are set out in the lease agreement. For example, Real Estate Taxes might be paid by the tenant, but are the attorney fees to protest the real estate taxes also covered? Or another example, is what types of insurance is paid by the tenant? Building insurance and liability insurance for the interior of the store but does the liability insurance cover the liability for the common areas? Does the building insurance cover damage to the common areas? Or for example maintenance, in a shopping center maintenance and single tenant retail real estate where the tenant is leasing the BUILDING maintenance usually includes the tenant interior premises, the common area (including parking lot sweeping, landscaping and snow plowing) and MAINTENANCE of the HVAC. However, the lease does not typically include the tenant REPLACING the HVAC, or the roof, or structural walls and supporting members or floor slab and foundations.
As I have often said, “Leases are the history of of bad things happening in the past and the parties protecting against them in the future.” It is why leases that I did in the 1980’s were 20 pages and now a typical lease will run 40 to 50 pages long. The expansion of detail for common area and maintenance agreements between landlords and tenants has increased dramatically in recent years. There have been unscrupulous landlords that have tried to pass all kinds of personal expenses through to the tenant. There have been examples of landlords or their employees purchasing boats or getting their house painted or the landscaping done or and passing it through the common area maintenance.
Currently the pendulum has swung the other way with tenants pushing the bounds of excluding legitimate expenses out of expense billings. Large credit tenants who have hundreds if not thousands of stores push to exclude $500-$5000 per lease in expense audits every year. A $500 savings (and in many case more money) on every store in a 1500 store chain adds up to $750,000 which gives the incentive for the tenants to contest charges. Many retailers and restaurant chains audit common area expenses every year or engage service providers on contingency to audit the expenses of the landlord for a share of the reduction. Sometimes the only way to settle the matter and create a future framework for agreed-upon expenses is to litigate the matter. There are also some notorious tenants, who during the lease negotiation, will attempt to excise out legitimate expenses. Then will also contest the annual reconciliation every year and attempt to bully the landlord into accepting less reimbursement with the threat of deducting from the next month’s rent payment. If the landlord acquiesces to eliminating legitimate expenses the tenant can actually decrease the the property’s income by $.75 to $1.50 per square foot which ends up being a lot of money when spread out over a 10,000 to 30,000 square-foot store.
Keep in mind, Triple Net (NNN) leases will almost never pay for an investor’s income tax preparation costs or attorney’s fees associated with negotiating the lease. There are certain administrative costs that will always be paid by the property owner.
Additionally, since Retail Real Estate leases are written for extended periods of time, you as in investor are making a decision on the “Credit Risk” of the tenant. It is especially important that you evaluate the “Creditworthiness” of the tenant in a Single Tenant Retail Real Estate investment. The fortunes of many retailers that were the darlings of the investment community are subject to change as tastes and shopping patterns change. You may have heard of some of these names which have either faded into obscurity, exploded in fantastic bankruptcies or are limping into the precincts of “Non Going Concern”: Sears; Woolworth; Service Merchandise; Circuit City; Toys R Us and many others. These were all “Credit” tenants in their halcyon days.
The importance of properly evaluating tenant credit and tenant fit for a particular location are illustrated by two tenants in the same center we operate. One is a lease with Walgreens (signed in 1955) that was typed on special parchment legal paper and was signed before there were ZIP codes. The store has continually been at the top of the chain and Walgreens has changed with the times going from soda fountain/lunch counters to home health supplies for an aging population and now catering to a Hispanic influx of younger families. The other tenant was a 90,000 square foot Meijer store. Meijer is an exceptionally great company, financially strong and an excellent merchant. However, for this particular store it was smaller than a normal Meijer and they were not responsive to merchandising to the local population. Cook County Illinois also did not help with increases in minimum wage, insanely high real estate taxes and a tax on soda. The store ended up closing only four years after opening. Which gets us back to not only credit worthiness but also considering future changes in lifestyle and living patterns to make sure the tenant will be paying rent all the way through the term of the lease.
One last type of lease, with a Ground Lease the tenant typically pays for all maintenance AND replacements of the building and improvements because it is usually the tenant that has built the improvements. It is with a Ground Lease that you get closest to the ideal Triple Net (NNN) lease. However, Ground Leases usually have a lower rental rate because the tenant has spent the capital to build to building. There is less risk for the land owner and the improvements usually become the property of the land owner at the end of the lease.
The Triple Net lease or NNN lease is a the most common type of lease structure in Retail Real Estate in both Shopping Centers and Single Tenant Retail properties. When evaluating a property for acquisition it could be a fantastic Value Add opportunity if the Shopping Center has one or more tenants on short term Gross Leases. It could be an opportunity to restructure that lease at renewal into a Triple Net lease shifting future expense risks to the tenant(s). However, if the lease is a long term Gross Lease with no opportunity to change or renegotiate the terms or terminate the lease it would probably be unwise to move forward with a purchase of that property because of the declining income that would be expected in the future.
“You will get all you want in life if you help enough other people get want they want.” – Zig Zigler
LEGAL AND TAX COUNSEL: Concordia Realty Corporation and Michael J. Flight and their affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction or undertaking. Concordia Realty Corporation and Michael J. Flight highly encourage individuals and investors to seek the counsel of a qualified attorney as well as seek the counsel of a tax professional or Certified Public Accountant (CPA) to determine if there are any potential tax liabilities or consequences as the result of anything contained herein. NO GUARANTEE: All users of this website should understand there are NO GUARANTEES of any success, outcome or profitability of any transaction or undertaking, expressed or implied by Concordia Realty Corporation and Michael J. Flight or any of its members, shareholders, officers or affiliates and will NOT be liable for any financial or other losses or damages incurred as a result of any undertaking. Go HERE to view complete DISCLOSURES.
About the Author: Michael J. Flight
Let your investment dreams take flight with the expert help of Michael Flight, principal investor at Concordia Realty.
Michael has worked for more than 28 years and handled more than $500 million worth of real estate transactions on behalf of his clients at Concordia Realty. Michael began his business in the realm of retail real estate, with Concordia Realty now handling third-party property and asset management services for a variety of commercial real estate investments.
He also specializes in revitalizing distressed investments for partners, adding value for clients … including banks, insurance companies, and hedge funds. Michael has consulted for some of the top investment and development companies in the world … and now his knowledge is available to YOU.
Are you searching for someone who can maximize the full potential of your property? Not only do Michael and his team at Concordia specialize in intensive hands-on property management, but they also bring the right relationships with attorneys, consultants, and contractors to the table.
With extensive experience in development, leasing, sales, property management, and innovative financing techniques, Michael and his trained team have the ability to make your property into the cash cow you know it can be.