Triple net leases provide commercial real estate investors with stable income, predictable expenses, and inflation protection. For certain property types, these leases increase landlord profits, however, not all properties are suitable for triple net leases.
Some commercial real estate properties lend themselves to double net leases or gross leases. Is a triple net lease the ideal solution for your current – or potential commercial real estate venture? Answering this question requires the understanding of the different types of leases and the pros and cons of triple net leases.
Triple net lease definition
Triple net leases are a type of net lease. In a net lease, the tenant pays certain expenses. Because the tenant pays some expenses, the landlord receives a “net,” or portion, of the total monthly cost of the property.
By contrast, in a gross lease, the tenant pays the full amount to the landlord, and the landlord uses the money to pay all expenses on the property. What expenses does the tenant pay in triple net leases?
- Property taxes
- Operating costs
The operating costs category can include many types of expenses, depending on the property type and location. Common operating costs include the following:
- Snow removal
- Waste management
Triple-net-lease tenants pay a prorated share of property taxes, insurance, and operating costs. For example, if five tenants occupy equal square footage of a strip mall, each pays 20 percent of these expenses.
When tenants occupy larger and smaller spaces, the tenants with larger square footage pay a proportionately higher prorated share.
Triple net leases leave the owner with fewer responsibilities, which limits the risk of large expenses. However, in most triple net leases, landlords remain responsible for structural elements of the building. Structural elements, as opposed to operating costs, are not recurring monthly expenses.
They are also essential elements of the building itself, not systems that benefit a single tenant. Structural elements include the following:
- HVAC systems
- Outer (common area) walls
Owners are also often responsible for common area repairs, such as light fixtures and doorknobs in hallways. Though tenants may share the cost of cleaning and routine maintenance of common areas, landlords must often bear the cost of repairing structural elements in these areas.
Not all triple net leases are written alike. To attract tenants, landlords may accept increased responsibilities. In areas of high demand, the landlord may be able to require tenants to take on more responsibility for costs.
Gross leases require the landlord to collect the full cost of operating the property from the tenants. The landlord must then cover all the expenses, including taxes, insurance, and maintenance costs. This generates more work for the landlord and exposes the landlord to more risk. Tenants remain responsible for expenses within their units.
The landlord has the potential to make more money from a gross lease than from a net lease. Both types of leases are quoted on a per-square-foot basis. Because gross leases require landlords to factor tax, insurance, and operating costs into the per-square-foot price, they can charge substantially more.
If landlords succeed in charging more per square foot than the cost of tax, insurance, and operating expenses, the landlord boosts returns.
Double net leases
Double net leases require tenants to pay property taxes and insurance. Landlords cover the costs of structural elements and operating costs related to common area maintenance, while tenants remain responsible for expenses within their units. Single net leases are uncommon.
Triple net leases pros and cons
Pros of triple net leases
- Bondable leases
Also known as true triple net leases, bondable leases make tenants responsible for all expenses. The landlord simply collects the rent every month and need not worry about any expenses, even in the event of a casualty loss. For example, bondable leases require tenants to rebuild after a fire, even if insurance proceeds fall short of the cost.
- Ground leases
Ground leases grant tenants the right to construct a building on the property. Landlords keep the building after lease expiration.
- Long-term leases
Triple net leases, like most commercial leases, average at least five years and may go as high as 25 years. Provided tenants’ businesses remain prosperous, landlords enjoy reliable income, whereas, with residential real estate, vacancies may occur every year or more frequently.
- Inflation protection
Because typical triple net leases range between five and 25 years, they include a yearly increase of 3 percent to offset inflation. Few investments with the income and appreciation potential of commercial real estate come with built-in inflation protection.
- Audit rights
Landlords generally estimate the annual operating costs and require tenants to pay them in monthly installments. At the end of the year, the landlord can perform an audit to calculate the actual cost. If the costs are higher, the landlord bills the tenants for the difference.
- Landlords free to sell at any time
Though the landlord has agreed to a long-term triple net lease, he or she can still sell the property. After the sale, the new landlord must abide by the lease terms.
Cons of triple net leases
- Limit to upside potential
Though triple net leases contain inflation protection, the landlord cannot raise rents higher if inflation surpasses the percentage agreed to in the lease. In times of high inflation and rent increases, landlords may regret having agreed to a long-term lease.
- Vacancy risk
Long-term leases provide guaranteed income, but tenants are more likely to decline lease renewals because of the large commitment. Long leases also make it harder to find new tenants.
- The potential for very high reconditioning costs
Triple net leases are great while the unit remains occupied because any cost of the alteration to space falls on the tenant. However, each business is unique, and those unique needs often induce tenants to make changes that render the space unrentable.
In these cases, landlords must bear the entire cost of reconditioning the space to make it attractive to new tenants, which can severely dampen overall profitability. Commercial real estate offers return potential that far exceeds the stock market or residential real estate.
In addition to higher returns, landlords can use triple net leases to reduce their expenses and maintain a healthy cash flow. By creating and executing effectively negotiated triple net leases, commercial real estate investors ensure profitability.
Triple net leases contain complexities not seen in residential real estate. If you are interested in becoming a player in commercial real estate in Phoenix, you will need the help of a commercial real estate company that knows the market and can negotiate triple net leases for success.
LCI Realty helps investors find the Phoenix area’s most profitable properties and lease them on winning terms.