There is a certain subset of real estate investors who want the benefits of owning commercial properties, but not the hassle of managing them on a day to day basis. For this group, there are a number of ways to accomplish this goal, one of which is to purchase (or invest in) a property that has a “triple-net lease (nnn lease).”
In this article, we will describe what a triple net lease is, the pros and cons of buying a property with one, and we will provide some actionable tips on how to go about buying a triple net leased asset. By the end, readers will have a greater understanding of this unique real estate lease structure and should be able to determine if it is something that they would like to have in their own investment portfolio.
At First National Realty Partners, we are no stranger to NNN properties. We have participated in many triple net leased deals and believe them to be a good fit for a certain type of income investor. To learn more about our current investment offerings, click here.
What is a Triple Net Lease?
In order to understand what a triple net lease is, it is first helpful to understand how the economics of a typical commercial real estate asset work. To illustrate this point, imagine a typical commercial shopping center. There are stores with rent paying tenants, but there are also common areas that are used by all tenants and visitors to the center. These typically include things like parking lots, elevators, landscaping, and walkways. There is a cost associated with the maintenance and upkeep of these areas and the difference between a net lease and a gross lease is highlighted by identifying who is responsible for paying these costs.
In a gross lease, the tenant pays one monthly rental amount and the landlord pays the property’s operating costs which typically include common area maintenance, property taxes, and insurance. In a net lease, the tenant pays a lower base monthly rental amount plus their proportionate share of the operating expenses.
Broadly, there are three types of net leases that are commonly used in commercial real estate transactions:
- Single Net Lease: In a single net lease, the tenant pays base monthly rental plus their share of one of the major expense categories, usually taxes.
- Double Net Lease: In a double net lease the tenant pays base monthly rental plus their share of two of the major expense categories, usually taxes and insurance.
- Triple Net Lease: Tenant pays monthly base rent plus their share of all three major expense categories, taxes, insurance, and maintenance.
It is this last structure that is the focus of this article.
Pros and Cons of Buying a Triple Net Leased Property
For real estate investors intrigued by this prospect, there are pros and cons to buying a triple net leased asset.
Pros of Triple Net Ownership
There are many benefits to buying a triple net leased asset, but we want to highlight five of them in this article:
- Income: Like any commercial real estate asset, triple-net leased properties have the potential to produce a steady stream of income for the investors who own them.
- Stability: Triple-net leased properties tend to have long term leases (10+ years), which provide income and stability over a long period of time.
- Tenant Strength: Because triple net leases shift the burden of operational expenses and maintenance costs to the tenant, they tend to be associated with tenants who have the financial strength and expertise to pay them. For example, there are many national corporations who like the triple net structure including the likes of Walgreens, Starbucks, McDonalds, and CVS.
- Rent Increases: In addition to having a lengthy term, triple net lease agreements also tend to have built in rental increases. The result is that the income stream produced by the property also tends to rise slowly over time.
- Time Commitment: For many real estate investors, this may be the most important benefit. In a triple net lease structure, the tenant is responsible for maintaining the property, which reduces the time commitment necessary for the owner or property manager to do the same activity. This point alone is what allows investors to achieve the benefits of ownership without the hassle of management.
While these benefits can be significant, they must be weighed against the risks of a real estate investment in a property that has a triple net lease.
Cons of Triple Net Ownership
Like any real estate investment, there are potential risks that must be considered when buying a triple net leased property. Among them:
- Vacancy Risk: One of the most popular types of triple net-leased properties has just a single tenant, which can expose the owner to vacancy risk. The property is either 100% occupied or 0% occupied. The risk here is that rental income could fall to $0 overnight if a tenant decides not to renew a lease.
- Renovations/Re-Leasing: Many triple net properties, like drug stores and quick service restaurants, are built for a specific purpose. If a tenant decides not to renew a lease, it can be incredibly expensive to renovate the property for a new use. Or, it can be incredibly difficult to find a new tenant that will lease the space for the same use.
- Tenant Neglect: Because the tenant is responsible for maintenance, there is a risk that they don’t do it at all, or don’t do it to the property’s owner’s standards. For example, a long-term tenant could decide that they can live with a relatively small issue so they don’t make a needed repair. But, that issue could grow in magnitude over time and could become very serious by the time the tenant vacates a space. This would leave responsibility for the repair to the owner.
- Returns: Given the long term leases and high quality tenants, triple net leased properties tend to generate returns that are closer to a bond. They can have limited upside, which may not fit the return objectives of some investors.
Investors interested in triple net leased properties must weigh these risks against the benefits to determine if this strategy is a good fit for their individual real estate investment objectives.
Ideal Triple Net Leased Property Locations
Triple net leased properties tend to be particularly prevalent with office and retail property types. As such, the ideal locations for these property types tend to be in high traffic areas where there is excellent visibility from the road and easy access to the office building or shopping center.
In our own case, we tend to like single tenant, freestanding, triple net lease properties that are “outparcels” to popular shopping centers. Usually, these properties are bank branches, quick service restaurants, or coffee shops.
Triple Net Lease Business Types
Technically, a triple net lease investment opportunity could be found with any business type, but there are certain ones in the office and retail space that tend to be a good fit.
Restaurants like McDonalds, Chipotle, Dave & Busters, and Burger King are popular triple net lease investment properties. So are coffee shops like Starbucks, bank branches, drug stores like Walgreens and CVS, convenience stores like 7-11, gyms like LA Fitness, gas stations like Sunoco, and big box retailers like Best Buy.
How to Invest in Triple Net Properties
For real estate investors interested in the passive income and relatively low risk associated with nnn investing, there are a number of ways to gain exposure to this type of investment:
- Buy a property directly. A simple internet search on a platform like Loopnet can help uncover available triple net leased real estate properties.
- Invest in a publicly traded REIT that specializes in triple net lease real estate investing. Popular choices include firms like National Retail Properties and WP Carey.
- Invest with a commercial real estate private equity firm who specializes in triple net leased properties. For example, we often present triple net leased opportunities to our investors.
Before going down any of these routes, it is always a best practice to perform individual due diligence and/or consult a triple net lease advisor to ensure the opportunity is commensurate with individual risk tolerance and time horizon.
What Are Good NNN Tenants?
Like most commercial real estate investment properties, the strength of a NNN investment is directly tied to the strength of the tenant (lessee). For this reason, it is critically important to perform a significant amount of due diligence on the tenant, their business model, their financial strength, and their payment history.
In some cases, this may be a relatively simple task. If the tenant is a publicly traded company like Walgreens or Starbucks, this information is widely available. In fact, the tenant may even have a credit rating with one of the major agencies like S&P or Fitch.
If the tenant is not a publicly traded company, the same due diligence still needs to be performed, but the information may have to come from the tenant themselves instead of public disclosures.
All tenants are different, but the best ones tend to have the following attributes:
- Established company with a viable business model
- Track record of operating profits and on time payments to lenders and creditors
- Manageable amount of debt
- Strong senior management
- Commitment to the location
All of these factors should be reviewed during the due diligence period.
Are Triple Net Properties a Good Investment?
The answer to this question is somewhat subjective.
For real estate investors seeking stable cash flow, passive income, and relatively low hassle, triple net properties can certainly be a good investment.
For those that are seeking growth and capital appreciation, triple net properties may not be the best fit because they tend to have somewhat limited upside.
Summary & Conclusion
A triple net lease, sometimes called an NNN lease, is a type of commercial real estate lease where the tenant is responsible for paying a base monthly rental amount plus their proportionate share of taxes, insurance, and maintenance.
Real estate investors like triple net leased properties for their stability, long term leases, rental increases, and high quality tenants. But, they also present some risk in the form of vacancy, tenant neglect, and high renovation costs should a tenant decide not to renew their lease.
Triple net leases are particularly prevalent in office and retail properties so location is an important factor. The best locations are those with high traffic, good visibility, and easy ingress/egress.
Ideal triple net lease tenants are those with the experience managing their own properties and the financial resources to pay rent and operating expenses.
For investors who prioritize stability and consistency over capital growth, triple net properties can be a very good investment. But, those looking for high rates of growth may be somewhat disappointed with the bond-like returns of triple net properties.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Real Estate Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.