Triple-Net Lease Investing: The Basics
Triple-net (NNN) lease properties are generally some of the most successful commercial real estate investments.
If done right, NNN leases can be a valuable source of consistent, long-term cash flow free of many of the headaches associated with property management. If done wrong, however, they can be a significant source of problems.
Here are some primary considerations when considering investing in NNN lease properties:
What are NNN Leases?
Unlike gross leases, net leases transfer one or more property expenses, in addition to rent and utilities, to the tenant. As the name implies, in an NNN lease situation, the tenant is responsible for most of these property expenses:
- Property Taxes.
- Property Insurance.
A single-net lease is a net of property taxes. A double-net lease is net of property taxes and insurance.
From the landlord’s perspective, NNN leases are the most desirable forms of net leases since only NNN leases free the landlord of maintenance obligations.
Typically, NNN leases are ideal for stand-alone commercial properties with a single tenant with lease terms of ten or more years. Sometimes a property will have several tenants with the common area maintenance (“CAM”) charges split pro-rata between the tenants.
Owners of NNN lease properties are responsible for the structural upkeep of the building.
Advantages of NNN Leases
With the right tenants, NNN Leases provide stable, consistent, recession-resistant income. Once you pass on most incidental property expenses to the tenant, investors can derive higher operating profits, and with longer terms, can profit from appreciation in the long-run.
Even though the above-average risk-adjusted returns commercial real estate can provide, there are no guarantees. This is no different from NNN lease properties.
Single-tenant NNN leases can be susceptible to bankruptcy and termination of lease risks resulting in burdensome expenses when the property remains vacant. If the occupant vacates, all the property costs, insurance, and maintenance are the responsibility of the landlord.
Also, since single-tenant NNN properties are typically geared for particular tenants (e.g., restaurants, retail), it could not only be difficult and time-consuming, but costly to find a compatible replacement tenant if the original tenant vacates.
Finally, as with most long-term investments, single-tenant NNN properties are susceptible to interest rate risk. If interest rates rise at the time of disposition, the selling price of the property will decrease because of the increased finance cost to a potential buyer.
Keys to Success
The key to successful NNN lease property investing lies almost entirely in tenant screening and selection. There are certain traits to look for in a tenant to ensure the highest likelihood of success. The tenant should be:
- Have considerable investment capital of their own (i.e., have skin in the game).
- Have a proven business model.
- Ideally, have the backing of a public, corporate parent.
Established national public franchises or chains with deep pockets and a proven success rate such as pharmacies, fast-food restaurants, and dollar stores are ideal potential tenants for NNN lease property investments.
Whether you’re considering direct investment in NNN lease properties or indirect investment through a private fund, there are critical fundamentals to keep in mind to accurately analyze a NNN lease investment opportunity.
NNN leases can be a valuable source of consistent, above-market cash flow, but with either the wrong tenant, the wrong property, or the wrong location, they can be a money pit.
However, with the right tenant, it can provide guaranteed cash flow for minimum terms of ten years along with the bonus of profits from appreciation.