All About Triple Net (NNN) Leased Property Investments
Single Tenant NNN properties are typically free standing buildings that are leased to a single business tenant for a long term, often 10-25 years. Triple Net (NNN) originally meant net of taxes, net of insurance, and net of maintenance – hence triple net. According to the terms of an absolute triple-net lease, the tenant is responsible for all property operating expenses, including insurance, taxes and internal and external maintenance.
NNN properties offer the benefit of little or no management responsibilities, as the tenant pays for most, if not all, of the expenses depending on the terms of the lease. The investor receives the rent with little to no other involvement. With an absolute triple net lease, the tenant is responsible for all expenses, making this a true passive investment for the owner, and allows an investor to buy property farther afield from his home.
Triple net lease commercial tenants are generally high quality business tenants and they usually have a vested business interest in seeing that a location is well maintained and attractive to customers. As a result, the tenant has an economic incentive to enhance the real estate investor's property over time, and frequently the tenant will make significant property improvements at their own expense.
Single Tenant NNN Properties include Retail, Industrial and Office buildings. Major restaurant chains like Burger King and Taco Bell operate under triple net lease agreements. Retailers like Toys R Us and Home Depot, as well as specialty service centers like Jiffy Lube and Pep Boys, also sign on for long-term triple net lease agreements. Industrial businesses like FedEx, distribution centers, and manufacturers operate under triple net leases. Medical Offices, R&D Facilities, and Educational Institutions are also frequently triple net leased properties.
How is the lease in a Triple Net Lease Property different from other types of leases?
Single tenant triple net leases differ from other types of leases in two important ways – 1) the numbers of tenants, and 2) the tenant’s responsibilities.
Most other commercial property investments - such as office buildings, apartments and retail properties - have multiple tenants, and the real estate owner must pay the operating expenses and provide on-site management. The owner takes care of leasing out individual units for short terms, renovates the premises as necessary, collects the rent, pays the property taxes, maintains the property, and is responsible for all insurance, legal, accounting and other expenses. This is often costly and painstaking work, which is eliminated under a single tenant triple net lease.
In a single tenant triple net lease agreement, a corporate and/or individual tenant agrees to be responsible for all of the expenses associated with the ownership of the property in return for a long term lease. The investor/owner’s role in a triple net lease is thus a passive one – effectively like “coupon clipping” in bond investments. The investor’s “job” is merely to collect the regular lease payments.
An added investor benefit in a triple net lease can be property improvement over the term of the triple net lease. Conscientious, credit-worthy corporate tenants usually improve the appearance and functionality of their leasehold in order to be more successful with their clients or customers. As a result, their leasehold is well maintained, and may even appreciate in price as a result of improvements, which would represent an additional return to the investor at the time of sale.
A triple net lease deal is generally structured in one of three ways:
1) Sale/Leaseback: A sale and leaseback financing is structured through the sale of a property owned by a strong business. The business/tenant sells the property to an investor, and leases it back on a long-term triple net lease.
2) Build-to-Suit: A developer enters into a long-term agreement with a corporate tenant, builds the facility to the tenant’s specifications, and then sells the property with the new NNN lease upon completion of the development or before.
3) Existing Property Sale: The sale of an existing triple net leased property by a third party investor.
What is a Sale/Leaseback?
A sale/leaseback is when a business sells its commercial property for current market value and then leases it back from the buyer, typically using an absolute triple net lease. The seller retains the use of their real estate and frees up capital which can be used to invest back into the business. Real estate sale/leasebacks are popular with business owners because they generate capital for immediate use within the business, and create a predictable rent that is deductible for federal and state income tax purposes. At the same time they are popular with real estate investors because they create a long term lease with a quality tenant on an absolute triple net lease.
What are the primary benefits of a Triple Net Lease investment?
Triple Net Lease investments benefit investors and tenants alike. Tenants with a Triple Net lease enjoy the security of a long term lease at favorable pricing, and control over the property in which their business is housed, as well as control of subsequent maintenance and renovation costs.
Investors similarly enjoy the security of the long term Triple Net lease, and the high cash return on their passive investment, as they own the property yet have zero on-site management responsibilities and no operating expenses.
Triple Net Lease investments are also flexible and offer additional upside, as at any time the investor can cash-out, most often with a profit, by selling the property, as the value of the real estate frequently appreciates during the lease term. The investor also can hold the property, allow it to further appreciate in market value, and lease it again at a higher rate to the original tenant or a new tenant when the lease term expires.
Finally, Triple Net investments are also relatively easy and safe for investors to engage in, as they are hassle-free transactions with minimal costs, and present a minimal risk with strong tenants and long leases. An investor can also choose an opportunity for higher cash returns by taking on less than investment grade tenants.
How are NNN Properties Valued?
NNN Properties typically are valued using their Capitalization Rate, also referred to as a Cap Rate. Cap Rates are a simple way to compare the value of a stream of economic benefits in a given property. Generally this is computed as a pretax cap rate using the property’s Net Operating Income (NOI).
A property’s NOI is the property’s gross income less all expenses (except debt service). In an absolute triple net lease, the annual rent is the same as the NOI. The Cap Rate is simply the NOI divided by the purchase price.
For example: if the purchase price is $1,000,000, and the NOI is $100,000 per year, then the cap rate is $100,000 divided by $1,000,000 = 10% Cap Rate
Some of the major considerations when determining what the cap rate ought to be on a particular building are:
- The credit worthiness of the tenant.
- The length of the lease – longer is usually better
- Type and frequency of bumps or increases in rent.
- Strength of the demographics of the property location
- Nature of the improvements. Are the improvements easily converted for another tenant or are they special purpose that would require significant expense and time to convert before re tenanting?
- Age and condition of the improvements
- The Location of the property
The more positive the above factors are, the lower the Cap Rate should be, and the higher the value of the property. Conversely, if the above factors are weak, the Cap Rate will be higher, and the resulting value will be lower.
It is important to remember that markets are not perfect and low cap rate properties are not necessary a lower risk investment - they could simply be a bad investment that is over priced. Astute investors seek NNN Properties that are priced in their favor, with a higher cap rate for a property that has low risk factors.
Types of Net Leases
1) Absolute Triple Net (NNN): The tenant pays all operating expenses, including maintenance, repairs, taxes and replacement for the entire property, without limitation. The owners pay the mortgage only.
2) Triple Net Lease (NNN): Similar to absolute NNN leases but with additional owner responsibilities. The owner is generally liable for the structural components of the building such as the roof, foundation, load-bearing walls and parking. Leases will vary from deal to deal, so the actual lease on a property must be carefully read as part of the investment due diligence.
3) Other Net Leases (NN, N): These are leases which provide that the tenant pays two, or one, of the net lease components (Taxes, Insurance, Maintenance). So, for example, a double net lease might be one in which the tenant pays for taxes and maintenance, but not insurance. It is necessary to review the actual language of the specific lease to determine who pays what.
Types of Properties
Triple Net Lease investments are available for all types of existing or build-to-suit real estate, including:
• Service Centers • Office Buildings
• Fast Food Restaurants • Distribution Centers and Warehouses
• Industrial Facilities • Retail Stores
• Educational Buildings; • Health Care Facilities etc. etc.
Who Buys NNN Properties?
NNN Properties are appealing to those who wish to invest in commercial real estate investments with relatively low risk, solid long term income sheltered by depreciation, good capital gains and little to no management responsibility. At any time the investor can cash-out, often with a profit, by selling the property. The investor also can hold the property, allow it to further appreciate in market value, and lease it again at a higher rate to the original tenant or a new tenant when the lease term expires.
Summary of Investor Benefits
1. Security of both the tenant and the real estate
2. Hassle-free transaction with minimal costs
3. Substantial cash return on a passive investment
4. Property depreciation shelters a portion of the annual cash return from taxes
5. The value of the real estate appreciates during the term of the lease
6. Minimal risk with investment grade tenants
7. Opportunities for higher returns from regional and individual tenants
8. Investor owns property with zero on-site management responsibilities
9. Tenant pays property insurance, maintenance, improvements, and taxes