Maximizing Returns with Net Lease Investment Properties: NNN Real Estate, Absolute Net Leases, Double and Single Net Opportunities
Investing in Net Lease Investment Properties
Obligations as an owner (investor) can differ greatly between asset types and lease structures. The form of lease can have a profound impact on who maintains the property and how property operating expenses are paid for and reimbursed… or not. Depending on your desired level of involvement in day-to-day operations of your property, selecting the correct property type and lease structure to invest in will influence your actual and perceived returns. For example, an investor looking to invest passively in commercial real estate may get frustrated with a multi-tenant asset with high turnover, routine maintenance calls, and capital expenditures. Does this mean a more actively managed property type and tenant mix is bad, no, it’s just not the correct investment to meet their investment objective.
Investors looking for a more hands off investment should consider a net lease. The net lease structure is one form of lease common in commercial real estate, particularly for single-tenant buildings such as standalone retail stores, industrial properties, and office buildings. A net lease is a type of commercial lease agreement where the tenant agrees to pay (often directly), in addition to the rent, some or all of the expenses associated with the property. These expenses typically include:
Property Taxes: The tenant is responsible for paying the property taxes levied on the real estate.
Insurance: The tenant must cover the property insurance premiums.
Maintenance: The tenant is required to pay for the maintenance and repair costs of the property.
Structural Repairs: The tenant agrees to pay for all structural repairs (minor or major).
In essence, a net lease shifts financial and/or maintenance responsibilities for the property from the landlord to the tenant. This arrangement is often beneficial for landlords as it reduces their financial obligations and risks associated with property ownership. For tenants, it can provide a stable and predictable lease structure, albeit with greater property maintenance obligations and potentially higher overall costs due to the additional expenses.
Don’t be fooled, as indicated above not all net leases are the same. Within the structure of net lease agreements there are differences that even experienced investors need to pay close attention to. General guidelines:
Single Net Lease: Tenant pays for property taxes in addition to rent.
Double Net Lease: Tenant pays for property taxes and insurance in addition to rent.
Triple Net Lease (NNN): Tenant pays for property taxes, insurance, and property maintenance expenses in addition to rent.
Absolute Net Lease: Tenant pays for property taxes, insurance, property maintenance, and structural repairs.
At CapWise, the most common form of net lease structure our clients pursue are triple net (NNN) or absolute net. These lease structures tend to appeal to investors looking to diversify or simplify their commercial real estate holdings to less management intensive assets while maintaining the benefits of depreciation. Within the net lease space we often work with clients to secure commercial real estate financing or execute their 1031 exchange. Below we highlight the benefits and potential pitfalls of these two lease structures.
Benefits of Triple Net & Absolute Net Leased Properties:
Stable Rental Income: NNN / Absolute Net leases typically offer a more stable and predictable rental income for property owners. Tenants are responsible for paying all of the property operating expenses, including property taxes, insurance, maintenance costs, and possibly structural repairs in addition to rent. This can provide consistent income and reduce the landlord’s financial responsibilities. When considering these investments make sure to read your lease agreement closely, as many triple net and absolute net leases are advertised incorrectly and ownership bears a greater responsibility than indicated.
Passive Investment: NNN / Absolute Net leases are often seen as a more passive form of real estate investment. Landlords have fewer day-to-day management responsibilities since tenants handle property expenses, making it attractive for investors seeking a hands-off approach. Note, even these lease structures require investor oversight and if ignored can lead to negative implications down the road.
Lower Management Overhead: With tenants responsible for property expenses, landlords have reduced management overhead and fewer unexpected costs. This can lead to more predictable cash flow.
Risk Mitigation: NNN / Absolute Net leases can help mitigate the risk associated with property expenses and fluctuations in operating costs. Tenants bear the responsibility for these expenses, reducing financial exposure for landlords.
Longer Lease Terms: NNN / Absolute Net leases often come with longer lease terms, providing stability and reducing the need for frequent tenant turnover.
Capital Improvements: Tenants might be responsible for capital improvements or upgrades required by law or to maintain the building’s standards, adding to their financial burden.
Potential Downside and Disputes for NNN & Absolute Net Leased Properties:
For landlords, the primary downside of a triple net / absolute net lease is the potential difficulty in finding tenants willing and able to take on these additional responsibilities and costs. They may also face the challenge of ensuring that tenants adequately maintain the property, as neglect can affect the property’s long-term value.
Disagreements on Maintenance: There can be disputes between the tenant and landlord regarding the extent and nature of required maintenance and repairs. Tenants might feel that landlords are not contributing fairly to property upkeep. Similarly, a landlord may feel that a tenant is not keeping up on maintenance of the property, which ultimately reverts back to the landlord.
Lease Negotiations: Negotiating the terms of a triple net lease can be complex and requires careful attention to detail to ensure all responsibilities and potential costs are clearly defined and agreed upon.
Market Conditions Impact: In declining market conditions, the tenant might find that they are paying high rent or expenses on a property whose market value is decreasing, potentially making it harder to justify the costs. It is important to understand your market, demographics, and tenant trends to ensure to the best of your ability that upon lease renewal or the unfortunate event of a vacancy that you are able to negotiate from a position of strength to renew your tenant or back fill the property.
Insurance Coverage Issues: Conflicts can arise over the adequacy of insurance coverage and the handling of insurance claims.
Debt Financing: Securing debt financing can become increasingly difficult as the tenant lease term diminishes. As the primary form of loan repayment, lenders will scrutinize the likelihood the tenant will renew their lease beyond the remaining term and any changes in the market.
An attractive lease structure, a net lease, particularly triple net or absolute net deserve consideration as part of any real estate portfolio. Key to this inclusion is understanding your lease and obligations as a landlord. Failure to understand your obligations as a landlord and to maintain proper oversight of the tenant and their obligations can result in loss of cash flow and/or value. CapWise Commercial Advisors can help you assess these risks and make the right investment decision. We work closely with your legal and third party service providers to help you thoroughly understand your investment. Our experience with due diligence can uncover risks or tenant shortfalls early and help you document a clear understanding prior to close. Whether you are in a 1031 exchange, in need of commercial real estate financing, or trying to better understand your current real estate investment, please contact us, we look forward to working with you.