Getting to Know the NNN Meaning: Is It Worth Investing in?
A Triple Net Lease which is a NNN lease commonly known in the area of commercial real estate investment is a type of lease where a tenant is obliged to pay for operating expenses except for building rent itself. As usual, these expenses include maintenance fees, taxes, and insurance which are three ‘nets’. Today, a triple net lease is considered to be one of the most prospective and beneficial investments since it includes features like low risk, long-term passive profit, and minimum liability for the landlord.
In this overview, we’re going to shed light on the essential facts about the NNN lease, what benefits and pitfalls a lessee and landlord should know the main risks, and differences from other net leases.
Specifics of a Triple Net Lease: What Is It and How It Operates
A NNN lease is a popular type of lease used in cases of property investment when a landlord is free of responsibility to pay for operating expenses while a tenant should pay for house maintenance, taxes, insurance, repair, and structural improvements as well. With such conditions, there’s no risk of expenses increasing for real estate investors and the rent rate remains unchanged.
A triple net lease is a long-term commercial real estate lease that can last for 10 years on average and can be beneficial both for lenders and tenants. However, because of its duration, the expenses of owning the building can change greatly. That’s why in most cases investors structure this agreement in a way to pass those expenses to the lessees. Even so, a fixed rate for square feet of the rented space is mentioned in the contract to guarantee some price stability for a tenant.
Sometimes, people may confuse a NNN lease with an absolute net lease, full service, or modified gross. However, it’s important to clear up each lease specification and know personal rights and responsibilities. Let’s analyze the particular case: if a rented house is whole new, a lessee is responsible for its structural improvement, i.e. in case of roof wear-off or HVAC repair over time. But, if the building is old, it’s up to a landlord to pay for such capital spending.
2 Types of Commercial Net Lease: Full Service Gross and Modified Gross
Before a tenant starts searching for a rented space with beneficial agreement conditions, it’s essential to check all the details of the most popular types of commercial leases (besides a triple net lease) not to fall into the trap and be aware of all features of the given agreement.
1. Full service gross lease is an all-inclusive agreement for a tenant that is a one-agreed-upon rent sum contract. A landlord uses the income to cover expenses for building maintenance, taxes, and insurance. A property owner is responsible for the following expenses: taxes, maintenance, repair, insurance, and the needed improvements. An advantage of this lease is that a lessee pays for rent every month. Also, it’s suitable for long-term rent and the ability to concentrate on business management. This type of lease is mostly used for multi-lessees buildings when it’s possible to compare each tenant’s utility usage. There can occur some pitfalls for lessees like an unanticipated increase of operating expenses in a year or two and it wasn’t negotiated in the lease agreement.
2. A modified gross lease means something in between gross and triple net leases. It’s a full service gross lease basically which separates electrical and janitorial services. It can be beneficial for tenants having electrical power requirements outside the norm and is prohibited by landlords in the case of the full-service gross lease. So, here a tenant is responsible for some, but not all expenses – building maintenance & upkeep, and janitorial services. The rest is upon the landlord – they should cover taxes and insurance expenses.
To summarize, with a NNN lease the expenses for building maintenance and repair are up for a tenant, while in the modified gross lease the expenses are divided between a lessee and a property owner. In the case of a full service gross lease, a landlord covers all the expenses payments, whilst a tenant should pay for the rent sum.
Ins and Outs of a NNN Lease: What Aspects Are Crucial to Know for Tenants and Landlords
Pros for a Property Owner:
A triple net lease provides a landlord with a predictable cash flow, additionally, they should consider costs from exterior maintenance, i.e. HVAC maintenance, and roof upkeep. So, it’s a good option for a stable income source thanks to its long-term nature.
Minimum responsibilities since all the expenses pass to the tenant.
Stable long-term tenancy at least for 7-10 years.
Protection from increasing the operating expenses connected to property maintenance.
Risks elimination for a property owner due to long-term tenant occupancy during the whole term of the lease agreement.
Reduced property management duties by enabling landlords to focus on other projects.
Pros and Cons for a Tenant:
Meanwhile, a lessee should mind possible changes in utility usage and other expenses increase during the lease term.
Greater management duties including resolving issues with building maintenance, and paying for taxes and insurance expenses.
Tenants are responsible for all utilities which are great expenses, especially if the building space is big.
High possibility of appraisal fees raise for the commercial property that results in its value growth, so a tenant should pay higher taxes each year.
Lower rate for tenants than in other leases, since insurance and taxes costs are defined in the lease agreement for the whole term and can be preserved for the next lessee.
The rent rate can remain unchanged for decades because in case of property value growth in the area a landlord can’t increase their rent price.
A tenant isn’t obliged to pay for operating expenses if a landlord overestimates them.
Investing Opportunities in Triple Net Lease Property
To be short, a NNN lease can benefit investors in gaining constant and stable income from commercial property. As usual, the high-profit option is investing in REITs (real estate investment trusts) due to the opportunity to boost income rate, liquidy, security, and leverage ratio. For a property owner, it’s a chance to spend more time on other ventures if having extra ones, without thinking about major property-related expenses, except for common area maintenance fees and other few charges.
With the help of REITs, it’s easier to invest in commercial real estate by paying dividends to investors and the ability to get special tax advantages. The ETFs (real estate exchange-traded funds) enable to spread of investments into several sectors by avoiding possible risks.
Before investing, a landlord should clear up such points as the number of tenants in the property and whether it is necessary to be involved in its management or if it’s just an opportunity for passive income. So, there are several aspects a property owner should consider since they help to determine the investment opportunities of a particular space: location, the length of the lease, tenant’s reliability, conditions of property investment, etc.
If you’ve already determined what property to invest in, you’d better consult a commercial real estate broker who will assess whether the specific property investment is fitting for your business. Since there are enough risks with commercial real estate investment that may result in missed opportunities, hiring a professional advisor will set you up for the right decision.
It’s also preferable to define your criteria for tenants and lease terms because not all triple net lease investments can offer you a beneficial cap rate, not all lessees can provide you with good financial stability and a high credit rate.
Before getting started to invest, savvy investors craft their due diligence list of the prior owners to analyze the needs and specifications of the market, check their rights, past and current returns. Commercial real estate can be rewarding due to less competition because of possible complications with investing, so the number of investors in commercial space can be lower.
Hence, it can be both beneficial and risky to invest in the NNN lease property that depends on the proper type of investor and venture they run. Nevertheless, if a landlord wants to vary their property portfolio, investing in NNN real estate will prosper them pretty well.
What’s more, if a lender strives to be less involved in property management and gain profit each month, and wants to have active cash flow from the 1031 exchange then this option is perfect for them. But, still, everything depends on the time and effort a property owner is ready to put into their business, and what risk level is acceptable personally to them.
Few Details on the 1031 Exchange: What Does It Mean for the NNN Lease
The 1031 tax-deferred exchange is a fitting option for a real estate investor who is planning to buy a new property or sell their current one by enabling them to defer capital gains taxes. So, the 1031 exchange gives a possibility to avoid paying taxes for profit growth in the case an investor sells their real estate and re-invests the same property of the same or greater value. There’s no limitation on how many times you can do a 1031 exchange. However, this kind of tax deferment won’t be applied to personal residency.
Here are several points on why a 1031 exchange is popular among property owners:
Preserve and improve cash flow. It allows reinvesting the gained profit into the newly bought property, even if it’s more expensive than the prior one.
Have an opportunity to manage the property. For example, if you owned single-family houses, it’s likely you’d like to buy the property with less involvement for its control. So, your choice will stop at purchasing a multi-family building.
Simple real estate management for future investors, even without great experience in property investment.
Assets incorporation and division. Sometimes, having multiple properties is better than a single commercial building because of the opportunity to divide your assets between your children.
There’s a great chance to buy a vacation house after reinvesting it from some of your properties. However, you’ll face some difficulties and rules for this type of exchange.
Nevertheless, if you have little expertise in real estate investing, are not sure what lease agreement will fit your needs, or you’re absolutely new in this area, then it’s better to consult a financial advisor. An expert will build a strong plan for you considering all details of your revenue, cash flow, property condition, etc to offer you the most beneficial options of the 1031 exchange.
Another situation may occur when you delay the exchange, so you can hire a qualified intermediary who will hold the cash you got after selling the property, and will buy another one for you considering your preferences. This is a third-party exchange called a swap.
So, does a triple net lease make sense for business progress in commercial real estate? Whether a tenant and property, the owner will succeed from the lease agreement NNN meaning fruitful prospects for their activity in several years? If you are a landlord, then you’ll benefit from getting stable passive revenue monthly by passing the vast majority of expenses to a lessee.
For a building owner, the key sense of NNN meaning is low risk investment opportunities and less involvement. For a tenant, the situation is quite different: a lessee is obliged to cover most property expenses, taxes fees, and upkeep with the possibility to manage the rented space concerning personal goals.
The most beneficial commercial real estate means investing in multi-tenant property since an owner gets a higher passive income. What’s more, there will be higher revenue in the case of the location with lucrative opportunities for business growth.
To consider all the mentioned information about the commercial real estate investment opportunities and NNN lease terms, it’s needed to highlight that there is quite a wide range of options for an investor to choose the source they’ll invest in: office buildings, retail spaces, condos, or industrial areas. Sure, it’s possible to invest in different properties at the same time to gain multiple streams of revenue, but investors should check all the details and features of each property type and lease agreement before starting to invest.