Triple net leases, also known as NNN leases, are a common type of commercial real estate lease arrangement. Under a triple net lease, the tenant pays rent to the landlord as well as all property costs like taxes, insurance, and maintenance. This shifts most operating costs from the landlord to the tenant, making triple net leases popular with real estate investors. However, there can be significant costs associated with triple net leases that investors need to understand before making real estate investment decisions. In this article, we will take a close look at the various cost components of triple net leases and how they impact commercial real estate investment returns.
Base Rent Costs in Triple Net Leases
The base rent rate represents the minimum rent that tenants pay landlords each month. Base rents are typically quoted on a price per square foot basis, and this base rate forms the foundation for determining total rent costs. Landlords will seek to negotiate the highest base rent possible based on factors like property location, amenities, market rates, and tenant creditworthiness. Tenants will aim for lower base rents to control their real estate occupancy costs. Base rent rates can also increase over the lease term if escalation clauses are in place.
Pass-Through Expenses in Triple Net Leases
In addition to base rent, tenants in a triple net lease must directly pay or reimburse the landlord for property expenses like taxes, insurance, maintenance, and utilities. These expenses are ‘passed through’ to the tenant to manage. Since pass-through costs can vary each month, they add uncertainty to the tenant’s total occupancy costs. Landlords benefit by transferring the cost and hassle of managing these variable expenses. Typical pass-through expenses in triple net leases include: – Property taxes – Property insurance premiums – Common area maintenance (CAM) – Building repairs and maintenance – Utilities if not separately metered – Other operating expenses
Accounting and Administrative Fees in Triple Net Leases
To administer all the variable expenses and maintain accurate tenant accounting records, landlords will often charge an accounting fee in triple net leases. This covers the landlord’s cost for bookkeeping, billing tenants for reimbursable expenses, and preparing annual reconciliations of pass-through costs. Accounting fees typically range from 3% to 6% of the total pass-through expenses. Some landlords may also add in an administrative fee to cover their overhead costs for property management and personnel.
Capital Expenditures in Triple Net Leases
In triple net leases, major capital improvements are generally the landlord’s responsibility. This includes expenses like roof replacement, HVAC upgrades, parking lot resurfacing and other large investments that extend the useful life of the property. While tenants handle ongoing maintenance, landlords take responsibility for major capital expenditures since they retain ownership of the asset. Landlords will factor anticipated capital needs into the base rental rate over the full lease term to recover these periodic costs.
Lease Structure Impacts of Triple Net Leases
Beyond base rent and additional expenses, there are several structural factors built into triple net leases that also impact costs: – Lease term length: Shorter lease terms increase costs for landlords due to more frequent turnover and re-leasing costs. Tenants enjoy more flexibility. Longer lease terms provide more stability for landlords and tenants. – Rental increases: Base rents may increase annually based on a fixed percentage or CPI escalation to cover rising expenses. – Tenant improvement allowances: Landlords sometimes offer these upfront to attract tenants, adding costs later on. – Renewal options: Tenant options to renew the lease add certainty but reduce landlord flexibility.
In summary, triple net leases allow landlords to shift most property operating expenses to tenants, but leases come with significant cost considerations related to base rent, pass-throughs, capital expenditures, and lease structure that impact real estate investors’ net returns. Understanding these key cost components is essential for analyzing triple net leased investment opportunities.