Of all the real estate sectors, “triple net leases” stand unique in their structure. They were originally designed to allow large franchises to utilize and control property without having to invest significant capital, with the intent that they could use the money that would have been devoted to real estate to further expand their business. Today, triple net lease users range from private enterprise to even the U.S. post office. So what is a “triple net lease” and why is that an attractive real estate investment concept?
The basic structure
A triple net lease (also known as a NNN lease) is a lease agreement on a property where the tenant agrees to pay all real estate insurance, maintenance, and taxes (the three “nets”) on the property in addition to the actual rent. Effectively, the property owner (the Lessor) has no actual costs of operation during the entire time of the lease agreement. In this manner, the amount of the rent is the net operating income to the owner.
The length of lease
The typical lease length on a triple net lease is 10 to 15 years, but some can go as long as 30 years in some instances. Because of these lengthy time periods, some leases build in a CPI escalation to keep the rent in line with inflation. The bottom line is that these are extremely lengthy endeavors and it’s essential that the buyer understands this and the implied limitations on raising rents.
The importance of credit-worthiness
Because of the length of the lease, as well as the scale of the payments and the required finish-out that some tenants require, it’s essential that a successful triple-net lease be based upon only working with tenants that are worthy of such trust. While the U.S. post office or a huge private-sector company like GE may be a blue-chip tenant, others have a fair amount of risk and still others may be undesirable to even have as a renter. In fact, the cap rates that triple-net deals are valued on vary based on the credit worthiness of the tenant. It’s an essential part of the investment.
The unique attributes to this type of investing
The triple net investor is typically geared towards paying down debt (the rental amount is often comparable to the underlying mortgage payment) so the real profit comes from paying off the loan. In addition, the investor will be looking at the value of the building at the end of the lease, either to sell or rent at new market prices. For example, let’s assume that the investor uses the monthly to rent to pay down the mortgage for 10 years. When the lease ends, the owner is able to either re-lease the building to the same tenant at a higher price or to a different tenant, or can elect to sell the building which has hopefully appreciated in value. But the key item that triple net investing does not include is the potential for higher cash flow along the way or the freedom to sell the building for a higher use. You can’t spike up the rent under these agreements, nor can you sell the building for a different use before the lease expires. Even if Hyatt Regency calls you wanting to tear the building down and build a giant hotel tower, you won’t be able to act on that without the permission of the tenant, or the end of the lease.
Triple net leases are a unique derivative of real estate investing. They serve a special purpose that gives you a stable income over a long period of time, without any concerns of increases in insurance, tax or repair costs. Yet they also have unique limitations that should also be considered.