When searching for commercial properties, you will discover that the type of lease you sign will make a big difference. Absolute leases bookend the spectrum of commercial real estate leasing agreements.
An absolute gross lease would cause the property owner to be responsible for all expenses. While an absolute net lease arrangement places the tenant in charge of all expenses. Absolute "gross" and "net" variations are very unlikely. Commercial real estate lease agreements vary to reflect the risk between owner and tenant. More common are double net leases or triple net leases. The triple net lease — also known as an NNN lease — is one popular variation.
What is a triple net lease?
A triple net lease is a commercial rental arrangement in which the tennant pays rent plus all property expenses. These expenses include net property taxes, net property insurance and net common area maintenance. Hence, the name triple net.
A triple net lease is usually illustrated per square foot. For example, a listing might read, “$50 NNN per square foot, per year.” This means the annual base rent is $50 per square foot, with an undesignated amount of net taxes, insurance and maintenance fees.
Triple net leases can be applied to a single property or multiple properties. While any number of tenants is permitted, most are used for single-tenant arrangements. Terms usually start at 10 years, with rent increases built in to the lease.
Many property listings use the terms “triple net,” “NNN” or “turnkey.” These lease types call for tenants to pay property costs rather than defining strict expenses. As triple net arrangements can vary greatly, the lease outlines which parties are responsible for exactly what costs and how.
For example, some owners hire a property management company to oversee the real estate. This cost is then charged to the tenant or tenants proportionally. If the property is leased by a single tenant, the owner may ask the tenant to directly account for maintenance and management. Typically tenants are responsible for property expenses such as utilities, but not legal or accounting fees.
Any commercial real estate lease passes through the cost of taxes, insurance and maintenance to the tenant. A triple net lease does not necessarily mean that the lessee is paying more. A gross or net arrangement only indicates which party assumes more risk when these costs change.
With a gross lease, the owner prices property costs into the rent. As property taxes, and other costs fluctuate, the owner bears the risk of them increasing beyond the agreed amount. On the other hand, if costs are well managed or expenses fall, the owner makes a higher profit.
A triple net lease often has a substantially lower base rent because the tenant is responsible for other property costs. Although this gives the tenant more transparency over expenses, they also assume the risk of increases. Given the additional risk, triple net leases are common in particularly desirable locations. Here, a tenant is willing to accept more volatility to access an in-demand neighborhood.
Investor advantages and disadvantages
Real estate investors often seek out triple net properties for sale as they generate predictable income with little effort. NNN leases are usually long term, and tenant turnover is a less frequent concern. Additionally, if investors decide to later sell the property, they can use a 1031 tax-deferred exchange to roll the revenue into another triple net lease, tax-free.
Triple net leases are excellent from an investor perspective, but there are a few risks. Investors often purchase NNN properties with existing tenants. When doing so, it is important to identify the re-leasing period before purchase. This is so that the you don't risk acquiring a property with an outgoing tenant.
Tenant credit risk is another potential concern as the occupancy risks are higher. If the lessee in a single-tenant lease goes bankrupt or moves out for any reason, the property becomes completely vacant.
Only accredited investors — those who meet the Securities and Exchange Commission’s net worth requirements — can acquire triple net lease property. Others can tap into triple net lease commercial real estate through real estate investment trusts (REITs) that exclusively invest in triple net leases.