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.
What is a Triple Net (NNN) Lease?
A triple net (NNN) lease is a lease structure where the tenant is responsible for paying all operating expenses associated with a property’s records during their lease period. The triple net or NNN lease is considered a turnkey investment, as the landlord is not responsible for paying the operating expenses. 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
Commercial real estate property history, such as lease information fall along a spectrum from absolute net lease to absolute gross lease. The majority of commercial leases fall somewhere between the two and are considered a hybrid lease.
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 labeled an NNN lease, does not mean it’s actually an absolute net lease.
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 be called triple net but actually require the property owner 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 read the entirety of the lease. The only way to truly understand the terms and conditions of a lease are to actually read every detail. Simple labels like triple net, full service, or modified gross, which are commonly used by brokers and property owners, can tend to conflict with the actual terms of the lease.
What the NNN Lease Does Not Include
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 fairly small relative to the purchase price of a property, they are still not typically covered in a standard “NNN lease”.
Triple Net Lease Investment Risks
Another misunderstanding is that triple net leases are risk-free. While triple net investments do offer advantages, there are still several risks that should be taken into consideration. The primary advantages of triple net lease investments are a predictable revenue stream due to the long-term leases and pass-throughs, and a relatively hassle-free investment due to the low management requirements.
While these are compelling advantages, triple net leases do come with several inherent risks. First, because most triple net lease investments are for single-tenant properties, tenant credit risk should be considered. 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. But it is possible for a financially 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 risk should be taken into consideration.
Another risk to consider is re-leasing. Many 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 property owner. If the new owner does not have the 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
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. It is important before any investment to consider the tenant credit risk.
Many single tenant triple net lease deals involve publicly traded companies such as Starbucks or Walgreens. In these cases, 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.
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