For those who read our article about Mobile Home Park Investing, we discussed how the term real estate investor broadly encompasses many genres of property ownership. Continuing on the theme of analyzing the different subsets of real estate investing, another type of ownership is a triple net lease on a commercial property.
Triple Net Leases: An In-Depth Look at the Pros and Cons for Potential Investors
A triple-net lease is an increasingly popular form of commercial real estate lease. It shifts some of the responsibility for property expenses to the tenant, which can be an excellent option for entrepreneurial tenants who want more autonomy in their business dealings. Let’s explore a triple-net lease and its advantages and disadvantages.
What is a Triple Net Lease Agreement?
A triple net lease is a real estate agreement in which the tenant pays all expenses associated with the property, such as taxes, insurance, and maintenance costs.
In this arrangement, the landlord usually collects rent from the tenant and does not pay or reimburse for any additional costs. These expenses include property taxes, insurance premiums, and common area maintenance (CAM) fees—hence why it’s known as a “triple net” agreement.
Considerations for Investing in a Triple Net Lease Agreement?
Triple net leases are indeed a popular form of real estate investment. Deciding whether or not to invest in a triple-net lease agreement is an important decision that must be made carefully. There are several factors to consider, including the potential risks and rewards of such an investment.
● Higher returns. Triple net leases may offer investors higher returns than other forms of commercial real estate investments. This is because returns are usually based on a percentage of rent payments rather than on the appreciation of property value. As such, investors may be able to earn higher returns compared to typical rental properties without necessarily assuming additional risks or investing more time and money into renovations or repairs.
● Long-term opportunities. These leases tend to have longer terms than traditional commercial leases, which can lead to more stability in the return and better cash flow over time.
● Greater upfront costs. Triple-net lease properties typically require higher up-front costs than other types of investments. Purchasing such a property often requires significant funding from the investor. This capital will go toward covering the initial cost of purchase as well as any necessary repairs or renovations.
● Reduced risk. Triple net properties tend to attract higher-quality tenants. Well-known businesses often use this type of agreement, but tenant quality can vary with any lease.
● Longer hold periods. Since triple net leases are commonly used for businesses, it’s not uncommon for a 10-year lease term.
● Predetermined increases. Rent increases are often specified in the terms of the lease so increases won’t be a surprise for the tenant.
Advantages of a Triple Net Lease
A triple-net lease has some key advantages that make it an appealing option for both tenants and landlords.
For Tenants: One of the most significant benefits of signing a triple net lease is that tenants have greater control over their businesses. This is because the tenant is responsible for paying (and managing) all expenses associated with the property.
Since landlords don’t need to worry about taking care of these expenses themselves, they may be willing to offer more competitive rates on their properties. This reduced rental rate can be an advantage for tenants looking for better prices on rental space.
For Landlords: A triple net lease can be consistent regardless of changes in market conditions or other economic factors. This can provide some peace of mind for landlords since they know their rental payments will not be affected by changing market dynamics.
Because tenants are responsible for expenses associated with maintaining and operating the property, landlords can avoid additional overhead expenses like staff salaries and general maintenance costs, which can help increase triple-net profitability over time.
Another benefit of a triple net lease is that it helps protect landlords from potential liabilities associated with owning a commercial property, such as slip-and-fall accidents or tenant lawsuits. By transferring liability to tenants, landlords mitigate exposure to possible legal action if something happened on their properties that resulted in injury or damage due to tenant negligence or error.
In this arrangement, tenants pay all operating costs through rental payments rather than out-of-pocket expenditures by landlords. This arrangement helps increase cash flow over time, making investing in commercial real estate potentially more profitable when viewed long-term.
The Drawbacks of a Triple-Net Lease
One of the most significant drawbacks is that the tenant is typically responsible for all costs associated with managing, maintaining, and repairing the leased property. This means landlords have little control or oversight regarding regular maintenance or necessary repairs. The landlord can’t control how much money will be spent or how repairs and maintenance are completed. If the tenant decides to cut corners or delay maintenance and repair, that can lead to increased costs for the landlord once the tenant leaves.
Tenants who sign a triple net lease don’t have to worry about additional charges as part of their rent payments and are, therefore, less likely to take preventative measures when caring for the property. This may lead to higher repair costs down the road and more frequent repairs than would generally be necessary if tenants were held more accountable by their landlords.
No Control Over Cost Increases
Another major downside to triple-net leases is that they tend to put landlords at risk since they don’t have any control over any changes in local taxes or insurance rates on the property. Since these expenses are usually passed down from landlord to tenant, landlords must accept whatever amount is charged without having any say in the matter.
Little Recourse for Late Payments
If a tenant needs to catch up on their payments, it can take longer for a landlord to collect back rent. This can be due to some additional administrative hurdles, such as filing an eviction notice or taking legal action against nonpayment.
Investment Considerations
Investing in a triple net lease agreement has advantages, such as providing investors with stable rental income streams and potential tax benefits. However, these investments also come with certain unique risks. It’s essential to thoroughly understand the pros and cons before investing in a triple-net lease agreement.
This article is for informational purposes only and is not a recommendation or offer to buy or sell securities. Information herein may include forward-looking statements and is for informational purposes only. Forward-looking statements, hypothetical information, or calculations, financial estimates and targeted returns are inherently uncertain. Past performance is not indicative of future performance. None of the opinions expressed are the opinions of RealtyMogul. Advice from a securities professional is strongly advised, and we recommend that you consult with a financial advisor, attorney, accountant, and any other professional that can help you to understand and assess the risks and tax consequences associated with any real estate investment.