In United States real estate business, "Net Lease" is a term used to signify a lease structure
in which the tenant or lessee is responsible for paying a portion of or all of the common
expenses related to real estate ownership, in addition to base rent.
Real estate related expenses associated with ownership are divided into three categories
referred to as the three nets which are property taxes, insurance, and maintenance.
The rent collected under a net lease is net of expenses.
It therefore tends to be lower than, for instance, rent charged under a gross lease.
Net lease types include single net, double net, triple net and even bondable triple net
leases.
The term "net lease" is often used as a shorthand expression when referring to NNN leases.
An NNN Lease is a net lease, structured as a turnkey investment property in which the
tenant is responsible for paying the three major expenses associated with commercial
real estate ownership.
"NNN" stands for "Net-Net-Net", is pronounced "Triple Net" and represents the three most
common, consequential real estate related expenses:
N - Property Tax N - Insurance
N - Maintenance The rent the landlord receives from the tenant
is in effect net of expenses.
Variations of the NNN Lease Single Tenant Net Lease
NNN leased investments are generally leased to one single tenant and are thus referred
to as STNLs or Single Tenant Net Leases.
A NNN lease investment can however have two or more tenants, though it would not be considered
an STNL investment.
An example of this would be a Starbucks & MetroPCS which share a building under two separate
NNN leases, or a retail strip center where all tenants are wrapped into one NNN lease.
Both examples would be considered NNN leased investments; however they would not be STNLs.
The risk of default is spread out over more than one tenant in such NNN deals.
Such deals can appeal to investors seeking to spread risk, though the simplicity of collecting
one rent check from one tenant is forfeited.
Double Net Lease Another variation of the NNN lease is the
NN lease or "Net-Net" lease which is pronounced "Double Net" where the Net's generally refer
to property tax and insurance.
Double net leases, like triple net leases, are usually, though not always, single tenant
deals, however the landlord carries some extra financial maintenance obligation.
Some of the Discount Dollar stores and Auto Parts dealers operate under double net leases,
where the landlord is responsible for the roof and structure of the building.
The term "Net Lease" is tossed around loosely in the net lease industry, often used when
referring to a triple or double net lease; however there is a definite distinction between
a triple net and a double net lease even though some brokers erroneously use the term "Net
Lease" to describe both.
Double net leased investments generally trade at a slightly higher CAP rate than triple
net leased investments, because of the maintenance expenses which the landlord is responsible
for.
Brand new NN Deals with long-term builder warranties covering the roof and sometimes
structure can be attractive to investors looking for a higher return.
Risk Though NNN leased investments are considered
to be highly risk-averse investments, especially when leased to a national credit tenant, the
landlord is still exposed to some financial risk.
In the fine print of most NNN leases these risks are specified.
For instance, who carries the obligation to rebuild after a casualty or whether the tenant
must continue paying rent should the property be condemned?
In other instances, certain risks cannot be completely accounted for in the initial contract,
forcing the landlord to estimate these costs early on.
In this scenario, if the landlord's accountant does not follow through with changing the
invoices appropriately, it may cost the landlord thousands of dollars by the end of the taxable
year.
Although NNN lease investments carry relatively low risk, they require high levels of oversight
for these reasons.
In one variation of a NNN lease contract, the "Bondable NNN Lease" the tenant cannot
terminate the lease or seek any rent abatements under any circumstances—mitigating some
risk for the landlord.
Common Misconceptions A "Bondable NNN Lease", the most extreme form
of a NNN lease investment, is often used incorrectly in the net lease industry when referring to
NNN properties which are merely occupied by investment grade tenants.
The tenant's credit rating is a crucial factor which the lender takes into account in their
decision to lend on a property and under what terms; however, it is not the characteristic
which distinguishes a bondable triple net from a standard triple net lease investment.
When evaluating the value of the credit tenant’s credit, most brokers, and lenders, base their
analysis on the credit rating garnered by one of the major credit agencies.
Though these ratings are important, they don’t always paint the most accurate picture of
a company’s overall picture and future viability.
Some brokers offer the services of an in-house stock broker and analyze the credit tenant’s
financials and stock performance when the tenant is publicly traded on an exchange.
A great deal can be learned by examining the credit tenant’s stock performance in comparison
to other industry competitors.
Other readily available metrics such as the P/E ratio, PEG ratio, and debt-to-equity ratio
can be indicators of a credit tenant’s financial health.
STL Components & Values The value of a Net leased investment is determined
by the value of the Real Estate, the value of the credit tenant, and the value of the
lease itself.
In a standard NNN leased investment the landlord owns the land and building while collecting
rent from the tenant.
If the tenant chooses to leave or the landlord decides he wants a different tenant when the
lease term is up, he still owns the building and land.
The location of the land and the potential of re-leasing it should be taken into account.
Planned developments in the area as well as current and future demographic trends all
affect the real estate’s value.
The physical building should also be factored in when determining the real estate’s value.
The second determinant of value is the quality of the credit tenant.
This is generally determined by the tenant’s current credit rating and past financial reports.
Future financial projections are also an important indication of financial strength.
Most investors use the Standard and Poor's credit ratings.
In order to qualify as an investment grade tenant, the company must have be rated at
lease BBB- by Standard and Poor's.
Properties leased by credit tenants are in the highest demand and therefore command a
lower capitalization rate than non-investment grade tenants.
The third determinant of value is the lease itself.
As mentioned previously NNN leases are more valuable than NN leases because the landlord
is responsible for some of the expenses in a double net lease.
The length of the lease is also a determinant of value.
Generous rental increases, also known as rent bumps, add value to the lease and protect
the landlord against inflation.
Some leases also have a percentage rent kick in if their gross sales hits a certain CAP.
Most leases grant the tenant options to renew.
Are the current rents called for in the lease below market?
If they are the landlord has the opportunity to command higher rents when the lease term
is up.
Net Lease Planning as an Investment Tool NNN lease planning is a rich investment tool
which provides the investor with many opportunities to navigate an ever-changing market.
NNN lease investments are essentially inflation-protected bonds guaranteed by a credit tenant, rather
than a state or local municipality.
The tenant makes monthly payments to the landlord, while the real estate provides the investor
protection against inflation.
Bonds have long been a popular investment tool among retirees and high-income earners
seeking fixed income without having to pay taxes for years.
NNN lease investments provide similar tax advantages as tax-exempt municipal bonds,
without forcing the investor to settle for lower yields or opening the investor up to
a large capital gains hit.
If an investor were to purchase a bond in the secondary market and turn around and sell
it for a profit, years later, he would have to pay a capital gains tax on the profit,
regardless of whether or not the bond is exempt from state income tax.
This is not the case when investing in NNN leases because of the fact that although structured
like a bond, they are still considered real estate investments and therefor fall under
the same tax laws as such which means that they can be depreciated in the same manner
as similar income producing commercial real estate.
The taxes on the income they generate can be written off or deferred over the life of
the asset.
The investor of course has to pay said depreciation back when he sells, however this too can be
circumvented by evoking a Starker’s 1031 exchange and trading into another like-kind
property.
NNN leased investments are also financeable allowing the investor to leverage the credit
of their tenant and the interest payments would also be a write-off.
In addition to the numerous tax benefits, retirees often choose NNN leases when planning
their estate or retirement because of the straight forward nature of NNN lease investments.
A retiree can achieve long term, guaranteed, fixed income with rental increases from a
simple product and their Heirs will not be overwhelmed by the many complications associated
with wealth management.
See also Common area maintenance charges
Net lease References