As a property owner, one priority is to reduce the risk of unexpected expenses. These expenses hurt your net operating income (NOI) and make it harder to forecast your cash flows. But that is exactly the situation property owners face when using traditional leases, aka gross leases. For example, these include modified gross leases and full-service gross leases. Fortunately, property owners can reduce risk by using a net lease (NL), which transfers expense risk to tenants. In this article, we’ll define and examine the single net lease, the double net lease and the triple net (NNN) lease, also called an absolute net lease or an absolute triple net lease. Then, we’ll show how to calculate each type of lease and evaluate their pros and cons. Finally, we’ll conclude by answering some frequently asked questions.
What is a Net Lease?
A net lease offloads to tenants the responsibility to pay certain expenses themselves. These are expenses that the landlord pays in a gross lease. For example, they include insurance, maintenance costs and property taxes. The type of NL dictates how to divide these expenses between tenant and landlord.
Single Net Lease
Of the three types of NLs, the single net lease is the least common. In a single net lease, the tenant is responsible for paying the property taxes on the leased property. If not a sole tenant situation, then the property tax divides proportionately among all tenants. The basis for the landlord dividing the tax bill is usually square footage. However, you can use other metrics, such as rent, as long as they are fair.
Failure to pay the property tax bill causes trouble for the landlord. Therefore, landlords must be able to trust their tenants to correctly pay the property tax bill on time. Alternatively, the landlord can collect the property tax directly from tenants and then remit it. The latter is certainly the safest and wisest method.
Double Net Lease
This is perhaps the most popular of the three NL types. In a double net lease, tenants pay property taxes and insurance premiums. The landlord is still responsible for all exterior maintenance costs. Again, landlords can divvy up a building’s insurance costs to tenants on the basis of space or something else. Typically, a commercial rental building carries insurance against physical damage. This includes coverage against fires, floods, storms, natural disasters, vandalism and so forth. Additionally, landlords also carry liability insurance and perhaps title insurance that benefits tenants.
Triple Net Lease (NNN)
The triple net (NNN) lease, or absolute net lease, transfers the greatest amount of risk from the landlord to the tenants. In an NNN lease, tenants pay property taxes, insurance and the costs of common area maintenance (aka CAM charges). Maintenance is the most problematic cost, since it can exceed expectations when bad things happen to good buildings. When this happens, some tenants might try to worm out of their leases or ask for a rent concession.
To prevent such nefarious behavior, landlords turn to bondable NNN leases. In a bondable NNN lease, the tenant can’t terminate the lease prior to lease expiration. Furthermore, in a bondable NNN lease, rent cannot change for any reason, including high repair costs.
Naturally, the monthly rental is lower on an NNN lease than on a gross lease agreement. However, the landlord’s reduction in expenses and risk usually outweighs any loss of rental income.
How to Calculate a Net Lease
To illustrate net lease calculations, imagine you own a small commercial building that contains two gross-lease tenants as follows:
- Tenant A leases 500 square feet and pays a monthly rent of $5,000.
- Tenant B leases 1,000 square feet and pays a monthly rent of $10,000.
Thus, the total leasable space is 1,500 square feet and the monthly rent is $15,000.
We’ll now relax the assumption that you use gross leasing. You determine that Tenant A should pay one-third of NL expenses. Obviously, Tenant B pays the remaining two-thirds of the NL expenses. In the following examples, we’ll see the effects of using a single, double and triple (NNN) lease.
Single Net Lease Example
First, imagine your leases are single net leases instead of gross leases. Recall that a single net lease requires the tenant to pay property taxes. The local government collects a property tax of $10,800 a year on your building. That works out to a monthly charge of $900. Tenant A will pay (1/3 x $900), or $300/month in property taxes. Tenant B will pay (2/3 x $900) or $600 monthly. In return, you charge each tenant a lower monthly rent. Tenant A will pay $4,700/month and Tenant B will pay $9,400 per month.
Your total monthly rental income drops $900, from $15,000 to $14,100. In return, you save out-of-pocket expenses of $900/month for property taxes. Your net monthly cost for the single net lease is $900 minus $900, or $0. For two reasons, you are happy to absorb the small decrease in NOI:
- It saves you time and paperwork.
- You expect property taxes to increase soon, and the lease requires the tenants to pay the higher tax.
Double Net Lease Example
The scenario now changes to double-net leasing. In addition to paying property taxes, your tenants now must pay for insurance. The building’s monthly total insurance bill is $1,800. Tenant A will now pay (1/3 x $1,800), or $600/month, for insurance, and Tenant B pays the remaining $1,200. You now charge Tenant A a monthly rent of $4,100, and Tenant B pays $8,200. Thus, your total monthly rental income is $12,300, $2,700 less than that under the gross lease.
Now, Tenant A’s monthly expenses include $300 for property tax and $600 for insurance. Tenant B now pays $600 for property tax and $1,200 for insurance. Thus, you save total expenses of ($300 + $600 + $600 + $1,200), or $2,700. Your net monthly cost is now $2,700 minus $2,700, or $0. Since insurance costs go up every year, you are happy with these double net lease terms.
Triple Net Lease (Absolute Net Lease) Example
The NNN lease requires tenants to pay property tax, insurance, and the costs of common area maintenance (CAM). In this version of the example, Tenant A must pay $500/month for CAM and Tenant B pays $1,000. Added to their other costs, total monthly NNN lease expenses are $1,400 and $2,800, respectively.
You charge monthly rents of $3,600 to Tenant A and $7,200 to Tenant B, for a total of $10,800. That’s $4,200/month less than the gross lease monthly rent of $15,000. In return, you save ($1,400 + $2,800), or $0/month. Your total monthly cost for the triple net lease is ($6,000 — $4,200), or $1,800. However, your tenants are now on the hook for tax hikes, insurance premium increases, and unexpected CAM costs. Furthermore, your leases contain rent escalation clauses that eventually double the rent amounts within seven years. When you consider the reduced risk and effort, you determine that the cost is worthwhile.
Triple Net Lease (NNN) Pros and Cons
Here are the pros and cons to consider when you use a triple net lease.
Pros of Triple Net Lease
There a few advantages to an NNN lease. For example, these include:
- Risk Reduction: The risk is that expenses will increase faster than rents. You might own CRE in an area that frequently faces property tax increases. Insurance costs only go one way–up. Additionally, CAM expenses can be sudden and substantial. Given all these risks, many landlords look exclusively for NNN lease tenants.
- Less Work: A triple net lease saves you work if you are confident that tenants will pay their expenses on time.
- Ironclad: You can use a bondable triple-net lease that locks in the tenant to pay their expenses. It also locks in the rent.
Cons of Triple Net Lease
There are also some reasons to be hesitant about a NNN lease. For example, these include:
- Lower NOI: Frequently, the expense money you save isn’t enough to offset the loss of rental income. The effect is to reduce your NOI.
- Less Work?: Suppose you must collect the NNN expenses first and then remit your collections to the appropriate parties. In this case, it’s hard to identify whether you actually save any work.
- Contention: Tenants might balk when facing unexpected or higher expenses. Accordingly, this is why landlords must insist upon a bondable NNN lease.
- Usefulness: A NNN lease works best when you have a single, long-standing tenant in a freestanding commercial building. However, it might be less successful when you have multiple tenants that can’t agree on CAM (common area maintenances charges).
What are net leased investments?
This is a portfolio of high-grade commercial properties that a single tenant fully leases under net leasing. The cash flow is already in place. The properties might be pharmacies, restaurants, banks, office buildings, and even industrial parks. Typically, the lease terms are up to 15 years with periodic rent escalation.
What’s the difference between net and gross leases?
In a gross lease, the property owner is responsible for costs like property taxes, insurance, maintenance and repairs. NLs hand off one or more of these expenses to tenants. In return, tenants pay less rent under a NL.
What are the different types of leases?
A gross lease requires the landlord to pay all expenses. A modified gross lease shifts some of the expenses to the tenants. A single, double or triple lease requires tenants to pay property taxes, insurance and CAM, respectively. In an absolute lease, the tenant also pays for structural repairs. In a percentage lease, you receive a portion of your tenant’s monthly sales.
What does a landlord pay in a NL?
In a single net lease, the landlord pays for insurance and common area maintenance. The landlord pays only for CAM in a double net lease. With a triple-net lease, landlords avoid these extra costs altogether. Tenants pay lower rents under a NL.
Are NLs a good idea?
A double net lease is an excellent idea, as it reduces the landlord’s risk of unforeseen expenses. A triple net lease is best when you have a property with a single long-term tenant. A single net lease is less popular because a double lease offers more risk reduction.