Buying a property only requires money. However, managing a property requires money as well as time. A real estate investor is very well aware of this. Most property owners struggle to pay the maintenance cost of their properties for a long time. Being the principal owner of the property, you are bound to pay entire property expenses. This may not worry a few property owners initially when the building is new. However, this would certainly pose difficulties for them, along with time. Expenses such as changing the building’s roof when it wears out or paying the insurance fee are something that won’t bring a smile on the face of any property owner.
NNN properties are less management-intensive and include little-to-no landlord responsibilities.
In order to deal with these additional expenses, a property owner can either sell their property or put it to lease under the ‘triple-net lease’ investment, which is also abbreviated as ‘NNN lease.’ A true real estate investor would willingly lease out their property rather selling it. There is only one reason behind it, and that is profit. Leasing out a property under ‘triple-net lease’ is a more profitable investment than simply selling it out. How? Well, that you’ll be able to figure out yourself gradually. But before you run too fast on leasing out your property, it would be a wise decision to become familiar with a few terms that are commonly used in real estate lease investment. Let’s take a look at management-free net leased investment.
Property tax, insurance fee, and maintenance cost are the three nets in a triple net lease.
A ‘triple-net lease,’ also known as ‘NNN lease,’ is an investment structure under which the tenant is asked to pay the entire or some property expenses along with the base rent. As a result, the property owner gets rid of the burden of paying the property’s maintenance expenses. This kind of investment is quite appropriate for property owners who want to generate a steady flow of income from their property without giving away anything. Since the tenant is also responsible for paying the additional expenses of the property like the utilities, insurance, etc. the base rent of a property given under ‘NNN lease’ is generally low as compared to that of a property given on gross lease. But, what does ‘NNN’ mean? And why is it known as ‘triple-net lease’?
NNN is the short form of ‘Net, Net, Net.’ Generally, a net lease is of three types – single net, double net, and triple net – depending upon what expenses or how many operating expenses the tenant pays along with the rent. A triple net lease includes property taxes, insurance, and maintenance cost, which together known as ‘three nets.’ Similarly, in a ‘double net lease,’ the tenant is generally required to pay the property taxes and insurance fee of the property. Whereas, in a ‘single net lease,’ the tenant is just required to pay property taxes or one additional property expense along with the base rent.
An absolute ‘triple-net lease’ investment includes all three ‘nets’ in the agreement. Some real estate brokers often erroneously use the term ‘net lease’ to define both ‘triple-net lease’ and ‘double net lease.’ However, both net leased investments are different. Knowing the different types of ‘triple-net lease’ will reduce the risk of making an investment error.
Some net leases only include one or two operating expenses.
Single Net Lease –
NNN properties are generally leased to one tenant, and thus it is known as STNLs or Single-Tenant Net Leases. However, a ‘NNN lease’ investment can also have two or more tenants, though it wouldn’t be considered as an STNL investment. For example, Starbucks and KFC sharing the same building under the ‘NNN lease.’ Thus, both companies will pay the rent together. Such kind of investment may appeal to investors who want to minimize the risk of default, as in such cases, the risk of default spreads out to more than one tenant. For example, if either Starbucks or KFC goes bankrupt, then the other tenant will continue to pay the rent as described under their ‘NNN lease’ agreement.
Double Net Lease –
Double net lease or ‘NN lease,’ just a triple net arrangement, usually has a single-tenant arrangement, but not always. A ‘double net lease’ generally requires the tenant to pay the property taxes and insurance fee. Whereas the owner or the landlord of the property has to pay for some maintenance expenses. The basic difference between ‘triple-net lease’ investments and ‘double net lease’ investments is that the ‘double net lease’ investments trade at a slightly higher CAP rate than ‘triple-net lease’ investments. The reason is obvious. In ‘double net lease’ investments, the owner is responsible for paying the maintenance expenses, and hence the CAP rate is higher.
CAP Rate – Capitalization rate (CAP) is calculated based on the ratio between the annual operating income generated by the property or net annual proceeds and its current market value. For example, if a property’s net operational income is $100,000 (the amount left after fixed costs and variable costs are subtracted from the gross lease income) and its current market value is $1,000,000, then it’s CAP rate would be ($100,000/$1,00,0000)*(100) = 10%. The capitalization rate helps the investors to evaluate the current value of the property based upon its net operating income.
Well, you certainly require the services of a registered real estate firm to understand the technicalities of ‘NNN lease’ investments. However, it is always better to do as much research as possible before committing to a ‘NNN lease’ Investment. The reason why investors prefer ‘NNN lease’ investment is that it has many benefits for them. In fact, ‘NNN lease’ investments also benefit the tenant in some aspects.
Besides freedom from property management, net leased properties include the following benefits –
- The biggest advantage of a ‘NNN lease’ investment is that all major property expenses are covered by the tenant, which reduces the burden from the landlord’s head. Moreover, the ‘NNN lease’ investment is the best way for investors to ensure a steady flow of income.
- A ‘NNN lease’ investment is the best option for passive investment. As the risk of paying the building maintenance expenses is upon the tenant’s shoulder, the landlord in a ‘NNN lease’ investment enjoys 100% passive investment.
- Investors can defer capital gains taxes on ‘NNN lease’ investments using the 1031 Exchange. For example, if a ‘NNN leased property’ is sold, then the proceeds obtained from it can be used for purchasing another property with the luxury of deferring taxes imposed on the proceeds. “NNN 1031 Exchange’ is a good way to defer capital gains taxes on exchanging a leased property for another.
- Although ‘NNN lease’ investments are preferred by investors, they also have a few benefits for the tenant. The base rent of a property leased under ‘NNN lease’ is generally less than that of a property leased under the gross lease. Therefore, even though the tenant is burdened with property expenses, lower rent gives them some sort of relaxation.
Nothing else can be more worthy of appreciation than an investment plan, which can benefit the property owner as well as the tenant. However, just like a coin has two sides, ‘NNN lease’ investments also pose risks to investors along with the benefits.
You may also come across the following challenges with NNN investments –
- Although ‘NNN lease’ investments don’t pose bigger risks to investors than some other investments, the owner can be exposed to financial risk in some cases. For example, in case of a calamity (including natural disaster), the owner is responsible for rebuilding the property.
- The property owner is forced to estimate some expenses in advance, like fluctuations in property taxes, as it can’t be predicted in the initial contract. Therefore, even a single mistake can make you lose thousands of dollars at the end of the taxable year.
- In ‘absolute triple net’ lease arrangements, commonly known as ‘bondable NNN lease,’ the tenant is not allowed to end the lease or demand any rent abatements.
There is nothing much to argue in the fact that ‘NNN lease’ investments favor investors and landlords. However, the tenants also have a few things to cherish in ‘NNN lease’ investments. The biggest benefit a tenant receives in a ‘NNN lease’ arrangement is cost savings. Whereas, the landlord recognizes the steady flow of income as one of the major advantages of net leased investments.