The Triple Net Lease (NNN) in Commercial Real Estate

The triple net lease (NNN) is a unique long-term commercial lease agreement in which the
tenant promises to pay some or all of the property’s expenses along with the base rental rate.
This arrangement is in stark contrast to standard agreements in which most of the payments fall
on the property owner.

What specific expenses does a NNN include? How and why does it get used in commercial real
estate? Let’s explore these questions below.

Key Expenses

A NNN lease most often includes three major expenses: property taxes, maintenance and insurance. Some other costs might be included depending on the situation, namely through a tenant improvement (TI) allowance.

A TI allowance is an effective incentive for long-term leasing that encourages tenants to expand the building. The allowance is an agreed-upon amount per square foot that covers all construction costs, from flooring to electricals. The landlord can make exceptions to specific items.

The rental rate remains a part of the agreement and is lower than usual because of the tenant’s increased role in paying operational costs. Sometimes, the landlord will eliminate the rent for the lease’s first few months to allow the renter to focus on the other expenses. The TI allowance and free rent incentive make for a persuasive combination.

Advantages of NNN Leases

The low or free rent is the main advantage of a NNN lease. The current tenant directly benefits from the lower rate, while the landlord can use it to incentivize other people to lease the building in the future.

The landlord also has less responsibility because they effectively relinquished the building’s management duties to the tenant. They’re making a steady income with minimal overhead costs. Meanwhile, the renter has more freedom to change or add to the building to meet their business goals without making a significant investment.

A NNN lease can be ideal for both parties, assuming they’re financially stable. If not, complications quickly arise among all three major expenses.

Disadvantages of NNN Leases

The property tax arrangement is straightforward on paper. Once the tenant signs the lease, they take over the same tax rate the landlord or previous occupant was paying before. However, it’s usually more nuanced in practice.

If the appraisal on commercial property increases and the tenant can’t afford it, they must rely on the landlord to contest the assessment. Such a situation would cause tension between the two parties and might cause the renter to leave when the lease ends.

The tenant benefits from low maintenance costs if the property is in good condition. On the flip side, a shoddy building with high upkeep expenses works in the landlord’s favor. However, an occupant who is tight on money might choose not to report damage to avoid paying for it. Once the lease is up, the owner will be stuck with the unreported expenses.

The tricky maintenance situation also complicates the insurance policy. The tenant might have to pay for uninsured damage or increased deductibles. Someone who can’t afford these extra insurance costs may choose not to file a claim or renew the policy.

Negotiating a NNN Lease

Thorough negotiation is the key to avoiding a NNN lease’s potential pitfalls. Both parties have to establish caps on tax and insurance increases. If they exceed the cap, the landlord covers the extra costs.

If the landlord does not offer free rent, then the base rental rate also becomes the main topic of negotiation. Since the tenant agrees to take on most of the overhead costs, they have some leverage in negotiating a favorable rate.

There are many ways to calculate the tenant’s total contribution. The simplest way is to add up all expenses and divide the number by 12 to determine the monthly cost. This process works best with one occupant. The estimation gets more complicated when multiple renters are involved and requires careful planning.

Consider a Triple Net Lease

A NNN lease has many advantages if both parties are prepared for the commitment. People have more freedom and flexibility but also more responsibility to uphold their end of the deal. If your business is ready to sign a long-term lease and grow to a new level, a NNN lease might be the best arrangement. STRATAFOLIO can help you keep track of all your assets, leases and so much more. Contact us today for a personalized demonstration.