What is a Triple Net Lease Agreement?
This is a lease agreement between a landlord and a tenant where the tenant agrees to pay for the leased property’s maintenance, taxes, and insurance. This type of agreement is very important for commercial properties where the tenant seeks to have more control, and the landlord seeks to have a low-risk steady income.
Unlike a standard lease that covers the rent and utilities, the triple net lease is more complex and thus requires more complex computations to arrive at the rent to be paid. However, the insurance, taxes, and maintenance costs are all paid to the landlord, who remits it to the right accounts on behalf of the tenant and then communicates it to the tenant. Because the tenant is responsible for those extra costs, the rent in a triple net lease is lower compared to the rent paid for the same property in a standard lease.
This type of lease mainly applies to commercial properties such as industrial properties, free-standing buildings, and retail spaces.
This video gives a quick overview of a Tripe Net Lease
Three ‘Nets’ (Ns)
This type of agreement gets its name from the three additional ‘net’ expenses. They include:
- Net real estate taxes:
- Net insurance costs associated with building
- Net property’s maintenance cost
Due to the commitment required with this type of lease, it is beneficial to the landlord if the lessee is well established and has enough cash flow to comfortably meet the financial requirements over the life of the agreement. This makes it attractive to landlords who wish to lease to banks, technology companies, big pharmacies, among others. On the other hand, financially capable companies prefer to have this type of agreement because the rent is lower and they retain more control than they would in a standard lease.
Elements of a Triple Net Lease Agreement
This type of lease agreement should have the following elements defined:
- Date when the agreement is made
- The lessor and their address
- The tenant and their address
- The physical location of the property
- The size of space being rented
- Specify how the tenant will use the premises
- Duration of the agreement
- The amount and frequency of rent payments
- Rent status as the lease progresses
- Security deposit amount
- Declaration of what constitutes late rent
- Results of late rent payment
- Lease renewal options
- Definition of common area maintenance
- Record of initial payment
- First day of tenant’s property occupation
- Insurance coverage that must be maintained
- Notice handling
Benefits of a Triple Net Lease
Long term lease of the property: Triple net leases are mostly above 15 years and in some cases go up to 99 years. As a landlord, this type of lease ensures you don’t have to worry about the possibility of a vacancy.
Consistent income from the property: Since the tenant is covering most of the costs associated with the property, the landlord’s income is largely consistent throughout the duration of the lease. Without any surprise costs being incurred on the landlord’s side, they can easily project the income they will generate in the future from the lease agreement.
They are transferable: The lease can be transferred from one lessee to another while still generating a consistent unchanged income to the property owner. As the landlord, you can continue with your investment strategy since the income from the property is reliable.
Minimal management cost: with the tenant being in charge of the property, the landlord’s responsibilities are very minimal and mostly involve bookkeeping. This saves the landlord time and the cost of hiring a building manager.
Disadvantages of Triple Net Lease
The earning cap: This lease has a cap as to how much you can increase the rent over a long duration of time. In case of any change that makes your property more valuable, you forego the extra income when the lease is in force.
Difficulty finding a tenant: It is not easy to find a tenant capable of entering into this type of lease agreement. After an existing lease ends, the landlord can expect to take a while before they can get another tenant.
High rollover cost: After a tenant has been in the property for over 15 years, it is expected that the wear and tear will be significantly high. In most cases, the landlord has to make a significant investment to restore and upgrade the place to make it attractive to potential tenants.
What you should know before choosing Triple Net Lease
It is important that a landlord considers the type of lease that suits their needs and expectations in terms of risk, reward, and effort. To better understand how this type of lease is different, below are two other types of leases and an explanation of their scope.
Single Net Lease: Under this lease, the tenant only pays the net tax on top of the other standard rent and utility costs. This type of lease is not very common with commercial properties as the landlord passes minimal risk to the tenant. However, the rent under this lease is still lower than that charged on standard lease properties.
Double Net Lease: This type of lease requires the tenant to pay the net tax and net insurance premiums associated with the property. It is very attractive to companies as well as landlords and is one of the most commonly adopted types of lease. The risk passed to the tenant is significant and this leads to lower rent being demanded. All maintenance costs are covered by the landlord and are paid by them directly. The rollover cost associated with a double net lease is not significant and is thus preferred by the landlord. It allows the landlord to maintain control over the structure and integrity of the building while still passing on tax and insurance costs to the tenant. The challenge with this type of lease is the possibility of disagreements on the type and cost of maintenance undertaken. This can make the income from the property inconsistent and increase the chances of a conflict during the lease period.
This video explains the differences between Gross Net Vs. Triple Net Leases
What to Consider While Entering into Triple Net Lease
If it is the first time, the landlord should consult a real estate professional to give you an idea of what to expect if they choose to enter into this type of lease agreement. Below are some of the factors that should be considered before selecting a triple net lease.
One should consider the current rent of leasing the property and also the possible future rent based on inflation, demand change, and surrounding neighborhood development. This will ensure that the lease is not too under-priced on the landlord’s side or overpriced on the tenant’s side.
For instance, if the property is located in an area that is developing fast and all the surrounding properties are expected to sky-rocket in value, it is important that the landlord takes this into consideration. During the time when the lease is in effect, the amount of rent increase is limited and will sometimes not reflect the true value in fast-developing areas. Failure to take this into consideration can lead to the property owner losing missing out on potential income from their property.
The price of the lease also affects the associated property value. This can limit the financing capability for the property owner or lower the price at which the property can be sold. In cases where leased properties are to be used as collateral for a loan, the price and time of the lease impacts the loan amount offered.
It is easier to find tenants willing to agree to a triple net lease for properties located in commercial or industrial districts. If the property is not located in these areas, and the tenant is about to start looking for tenants, they should not lock out the possibility of accepting other types of leases. Failure to do so can lead to extended rollover periods that leave the vacant property incurring significant tax and insurance costs.
The ability for a potential tenant to consistently pay on time throughout the duration of the lease. It is important that the tenant objectively analyses the tenants financial capability before agreeing to this type of lease. For instance, if the potential tenant’s business does not have secure cashflow or sufficient capital, the landlord should either consider other types of short term leases or reject the offer and continue looking for a capable tenant.
It is important to understand the activity that the tenant will engage in so as to understand the expected wear and tear. If the wear and tear is significant, the landlord has to include a premium within the rent that will compensate for the significant cost that would be incurred in case of a roll-over. The activities that the tenant will engage in within the premises should be specified in the lease agreement to protect the landlord’s interest.
For instance, if the tenant is engaged in activities that can lead to the building being significantly destroyed by their activities that were not mentioned in the lease agreement, the landlord can move to sue for damages and terminate the lease. Alternatively, the tenant and landlord can agree on a new price that caters for the activities leading to excess wear and tear.
In sum, Triple Net Leases transfer most responsibilities associated with the property to the tenant at the expense of lower rent over a long period. Landlords get into this type of lease to secure steady low-risk income throughout the period of the lease. It is the obligation of the tenant to pay the net tax, net insurance, and net cost of maintenance on top of rent and other utilities consumed during their tenancy.