In a typical commercial real estate investment, the lease structure under which tenants are obligated to pay rent is one of the most influential factors in a property’s value. For this reason, it is critically important that investors understand the details of each tenant lease prior to committing capital to a property. But, this is easier said than done. There many different lease types and the specific terms are unique to each property.
In this article, we are going to discuss one specific type of lease known as the “double net lease.” We will define what it is, how it works, and how it compares to other types of commercial real estate leases. By the end, readers will be able to identify the defining characteristics of a double net lease and use this knowledge as part of their pre-investment due diligence process.
At First National Realty Partners, we read and analyze all property leases prior to acquisition and use this information to ensure we are presenting the most promising deals to our investors. To learn more about our current investment opportunities, click here.
Gross Leases vs. Net Leases
Commercial property leases can be grouped into two buckets, gross and net. The difference between the two has to do with who is responsible for payment of the property’s operating expenses.
In a gross lease structure, the tenant pays one monthly rental amount and the landlord pays for the operating expenses. Tenants like this structure for its simplicity, but the rent tends to be higher. Property owners like this structure because they can charge higher rents, but it also exposes them to the liability associated with rising operational costs.
In a net lease structure, the tenant pays a lower base monthly rent amount plus their share of the property’s operating expenses. Tenants like this structure because it gives them more control over which operating costs they are required to pay, but they also take on the risk of rising operating costs. Property owners like the net lease structure because they can pass responsibility for operating costs on to the tenant. But, the base rental income tends to be lower.
There are four types of commercial real estate net leases and the tenant’s share of operating expenses depends on which one they have signed. For the purposes of this article, the focus is on the double net lease.
Double Net Leases Explained
In a double net lease agreement – also referred to as a “net net lease” or “NN lease” – the tenant pays base rent plus their share of two of the property’s major operating expense categories, usually property taxes and insurance. In a single tenant property, the tenant pays all of these cost categories. In a multi-tenant property, they pay their proportionate share, usually based on the amount of square footage leased.
Advantages of Double Net Leases
The primary advantage of a double net lease is that it strikes a compromise of sorts between the property owner and tenant regarding operating costs. The tenant is responsible for property taxes and property insurance while the landlord is responsible for maintenance. As a result, a double net lease is usually viewed as a win/win for both the tenant and the landlord with regard to the equitable distribution of operating costs.
As described above, the double net lease is just one of four net lease types. The differences between the types are highlighted below.
Double Net Leases vs. Other Net Lease Types
In a commercial property, there are three categories of operating costs: property taxes, insurance, and maintenance. With this fact in mind, the double net lease can be compared to the other net lease types that could be found in an investment opportunity:
- Single Net Lease: In a single net lease, the tenant pays base rent plus their share of property taxes.
- Triple Net Lease: Also called a “NNN lease”, the tenant pays base rent plus their share of property taxes, insurance, and common area maintenance.
- Absolute Net Lease: In an absolute net lease, the tenant pays base rent plus all of the property’s operating expenses, which include taxes, insurance premiums, maintenance, and any additional costs that may be incurred. These could include things like repairs after a major storm or the costs associated with replacing a roof or HVAC system.
One of these commercial real estate lease structures isn’t necessarily better than the other, but they are designed to meet the unique needs of both the tenant and the property owner in a particular deal. Of the three types described above, the triple net lease is particularly popular with investors seeking passive income.
Investing In Double Net Leases
From a process standpoint, there isn’t anything substantially different about investing in a property with a double net lease versus one of the other types described above. However, the key difference lies in identifying which party (the property owner or tenant) has financial responsibility for which operating costs. This information can be obtained from reading each individual lease.
Once identified, these details can be plugged into the property’s financial model to calculate key return metrics like cash flow, internal rate of return (IRR), and equity multiple.
Summary & Conclusion
A double net lease is a commercial property lease type that requires the tenant to pay base monthly rent plus their share of property taxes and insurance.
The primary benefit of a double net lease is that it strikes a balance between the tenant and property owner with regard to the equitable distribution of operating costs. The tenant pays for real estate taxes and insurance and the landlord pays for maintenance.
There are three other types of net leases, single net, triple net, and absolute net. The type chosen for a property should reflect the unique needs of both the tenant and the property owner.
For individual real estate investors, there is no substantial difference between investing in a property with a double net lease vs. the other options. However, the key details of each lease must be obtained from reading them and this information should be plugged into the property’s financial model to maximize the chances of an accurate return measurement.
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 email@example.com for more information.