Investors interested in commercial rental property will find occupied properties have widely varying lease terms, with differing obligations for both the landlord and the tenants. Some tenants merely pay a fixed rental payment and are not responsible for any property taxes or maintenance costs. Other tenants will pay some or all the property taxes in addition to their rental payments. Often, selective investors prefer to purchase properties with triple net (“NNN”) tenancies. Under a NNN lease, the tenant is responsible for both rent payments and for all operating expenses associated with a property, including:
- Property Taxes
- Building Insurance
- Maintenance and Replacement Costs
Typically, NNN leases are used for commercial buildings with a single tenant and have initial lease terms of ten years or more with agreed upon rent increases. Since the tenant covers costs that would otherwise be the responsibility of the landlord, the rent charged in a NNN lease is traditionally lower than the rent charged in a standard lease where a tenant has less responsibilities. In exchange, the building owner is protected against any surprise expenses.
Under non-NNN leases, a landlord must estimate future property taxes, building insurance, and maintenance costs for the lease term and hope the agreed upon rent is sufficient. Because the cost of property taxes, building insurance, and maintenance and replacement costs can fluctuate from year to year, properties with non-NNN leases can be an unstable asset for property owners.
Real estate investors often prefer NNN leased properties because they create a steady and predictable income stream. A @Holm & O'Hara LLP client once described the experience as having twelve additional birthdays a year. By passing recurring obligations and incidental expenses on to the tenant, landlords do not have to guess how much net income they can expect each month. In addition, they do not have to create and maintain cash reserves for future repairs and maintenance. NNN landlords typically spend less time and money on lease renewals and renegotiations because NNN leases usually have longer lease terms and built-in rent increases. They also save on brokerage commissions, which can be quite costly.
Many tenants, on the other hand, value NNN leases because they generally have a lower rent and greater control over the buildings they occupy, including selecting their insurance policies (or self-insuring, if they qualify) and addressing maintenance and repairs on their own terms and schedules, provided that the property is kept adequately repaired and maintained as specified in the lease.
Investors interested in purchasing NNN leased properties should consider the lease terms, the tenant, location, zoning restrictions, and tax consequences. In this series of short blog posts we will examine each of these factors in turn.