Nearly all commercial real estate properties are purchased with some amount of debt. The terms and conditions of the debt are largely a function of the specific attributes of the deal presented to the lender.
In this article, we will focus on the typical terms and conditions under which a property with a “net lease” is financed. We will describe what a net lease is, why it is important, and what makes trying to finance a property with one unique. By the end readers will understand what a net lease is and the typical terms and conditions under which a property with one is financed.
At First National Realty Partners, the only properties we present to investors are those that have met a set of incredibly stringent investment criteria. On occasion, these include properties with net leases. To learn more about our current investment opportunities, click here.
What Is a Net Lease?
The defining characteristic of a commercial property is that it contains space that is leased to tenants. In most cases, the lease agreements fall into one of two categories, gross or net. The key difference between the two is who pays for the property’s operating expenses.
In a gross lease, the tenant pays one monthly rental amount and the landlord pays for all operating expenses. Tenants like this structure for its simplicity and landlords like it because they can charge higher rent. However, the higher rent is a downside for the tenant and property owners are exposed to the risk of rising operating costs.
A net lease is the opposite. Under this structure, the tenant pays a base monthly rental amount plus some portion of the property’s operating expenses. The exact portion is dependent upon the specific type of net lease, of which there are four:
- Single Net Lease: In a single net lease, the tenant pays base monthly rent plus one of the property’s major operating expense categories, usually real estate taxes.
- Double Net Lease: In a double net lease, the tenant pays base monthly rent plus two of the property’s major operating expense categories, usually property taxes and insurance.
- Triple Net Lease (NNN Lease): In a triple net lease, the tenant pays base monthly rent plus three of the property’s major operating expense categories, usually property taxes, insurance, and maintenance.
- Absolute Net Lease: In an absolute net lease, the tenant pays base monthly rent plus all of the property’s operating expenses.
Tenants like net leases for their low base rent and the opportunity to exert some amount of control over the property’s day to day operations. However, they are also exposed to the risk of rising operating costs in the net lease structure. In the long run, it is possible that this could cause a net lease to end up being more expensive than a gross lease.
Property owners and investors like net leases because they can pass the risk of rising expenses and certain property maintenance responsibilities on to the tenant. But, their rental income may be slightly lower and they may be exposed to some vacancy risk, particularly in the instance of single tenant, net leased properties.
Because the net lease structure is widely used, there are a variety of lenders who are willing to provide financing for this property type.
Financing a Triple Net Lease Investment
Financing is available for net leased properties through a number of channels including traditional retail banks, real estate specific lenders, and even life insurance companies. The approval criteria, loan terms, and conditions can vary from one lender to another so it is possible that one lender could approve a loan while another one may decline it.
For this reason, there are a number of factors that real estate investors should consider when attempting to finance the purchase of a triple net leased property.
Factors to Consider with NNN Lease Financing
Generally, net lease properties are able to obtain favorable loan terms. Prior to finalizing a loan, borrower/investors should review key elements of the loan structure like: interest rate, term, LTV, amortization period, prepayment penalties, and whether it is a recourse or non-recourse facility.
In a NNN lease, the tenant is responsible for rent and operating expenses. As a result, lenders want to ensure that they have the resources to meet all of their financial commitments for the duration of the lease term. When compared with gross-leased properties, net leased lenders spend more time analyzing the tenant to ensure they are stable. Tenant analysis typically includes a top down review of their business model, reputation in the market, and financial statements for a multi-year period.
Net leases are particularly common with office and retail properties. As such, their location is a critically important component of the transaction. To ensure it is adequate, net lease lenders will review things like: supply and demand in the market, ease of ingress/egress to the property, parking, competition in the local area, and proximity to major highways, bus stops, and other public transportation.
The details of triple net lease agreements are an important component of building a financial model for the property. As such, lenders will review them carefully for specifics like: rent amount, rent escalations, which expenses the tenant is responsible for paying, and financial penalties for default. Often, these details are surfaced by completing a document known as a “lease abstract.”
Term of the Lease
When dealing with NNN properties, especially those with a single tenant, lenders will often match the term of the loan with the remaining term on the lease. For example, if the tenant has a long term lease of 15 years, the lender may structure the loan with a 15 year term to match.
Tenant Credit Rating
Net lease tenants fall into two categories, credit and non-credit.
Credit tenants are large, financially secure corporations that have an investment grade credit rating from a major agency. Popular examples of low risk, investment grade tenants are companies like Walgreens, Starbucks, CVS, and Dollar General.
Non-credit tenants are those without a credit rating. They may pose a higher level of credit risk for borrowers/investors so lenders may be less likely to approve a loan that is secured by a property with a non-credit tenant.
Type of Tenant
Because the tenant’s ability to pay rent is critical to repayment of a net lease commercial real estate loan, lenders will often perform due diligence on their business to ensure it is stable. For example, a clothing or electronics store likely presents a higher default risk than an essential retailer like a grocery store. As a result, the lender may be less likely to approve a loan for the clothing or electronics store than they would for the grocery store.
Summary of Triple Net Lease Financing
A net lease is a type of commercial real estate lease in which the tenant is responsible for paying a base monthly rental amount plus some portion of the property’s operating expenses.
There are four types of nets leases, of which triple net lease properties are particularly popular with commercial real estate investors.
Financing for net leased properties is available through a variety of channels and loan programs including traditional retail banks, dedicated commercial real estate lenders, and even life insurance companies.
When obtaining financing for net leased properties, particularly those with a single tenant, lenders pay special attention to the tenant, their business model, and the details of their lease.
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.