When I talk to potential investors about the possibility of investing in commercial real estate, one of the biggest misconceptions is net rent. A net lease is a commercial real estate investment in which the lessee takes on more responsibility for the building, while giving the owner less management responsibility. In this article, we will discuss the three main types of net-rental properties – modified nets, triple nets (NNN), and double nets (NN) – and how each can benefit different types of investors and their investment criteria.
Modified Net
In a modified standard net lease, the tenant pays for all utilities, building maintenance, repairs, and insurance. However, landlords are still responsible for property taxes and everything else.
The benefit of this type of lease is that the tenant has an interest in the property and is more likely to take care of the property. With the tenant paying for their own maintenance, repairs, and insurance, they are sure to maintain the property for future use. In contrast to properties without a modified net lease, the lessee is only responsible for basic liability and utility insurance. Therefore, modified leases provide landlords who are more concerned with the building and reduce management responsibilities.
The down side of this type of lease is that there is still a management responsibility associated with this lease structure. For example, landlords still have to ensure that property taxes are paid and are generally responsible for roofs and structures. Therefore, if there is a leak in the roof, guess who is calling the tenant?
Modified leases are better than traditional commercial leases but are at the lower end of the spectrum when it comes to net rents. Investors who may be interested in this type of lease don’t really care about management responsibilities, but like the idea of having a tenant who pays for maintenance, repairs, and insurance.
Three Nets (NNN)
Triple net leases or NNN leases are likely to be the industry norm and most sought after. In a standard triple net lease there is usually a cap on the cost of capital. However, the tenant is responsible for the cost of the property which includes property taxes, property insurance, and maintenance.
The benefit of this type of lease is that the owner has almost no responsibility related to the management and maintenance of the property. Often times, triple net or NNN rental properties are guaranteed by corporate credit tenants such as Walgreen, CVS, Burger King, McDonalds, Borders Bookstores, etc., which cover the rent, including taxes, maintenance, and insurance, for the entire lease term.
The disadvantages of this type of lease are minimal, but can have a major impact on the purchase price of the asset (property) in question. Basically, if the tenant who guarantees the lease is not a credit tenant, then they have a higher risk of default. A credit tenant is usually a public or private entity that has a strong credit rating by S&P. In situations where there are no credit tenants, it is wise for the investor to purchase a property with a higher capitalization rate, based on market standards at the time. Thus, offsetting the risks associated with purchasing NNN properties guaranteed by non-credit tenants. For example, if a franchisee leases a property, the corporation generally does not guarantee the lease. If the franchisee has financial problems and has to close, the chances of the investor being able to get the lease due for the remainder of the lease are drastically reduced.
An NNN lease or triple net lease investment is ideal for overseas investors, or investors who don’t want to bother with property management. In addition to paying off debt, investors can expect to receive a fixed rent check every month according to the signed lease.
Net Net or Double Net (NN)
Another net lease is Net Net or Double Net lease (NN). This lease is very similar to an NNN lease; however, the owner is generally responsible for structural damage such as roof and/or bearing walls.
The benefits of this type of lease are the same as the NNN lease. Again, the management task is reduced drastically in a rental situation like this.
Except for roof problems and structural damage, this type of lease has the same disadvantages as an NNN lease. In addition, many double net leases are actually settled by big brand franchisees who can afford much of what NNN tenants pay, but don’t want responsibility for roofing and structural damage.
Double net leases are also an ideal investment for overseas investors, or investors who don’t want the hassle of property management. The investor will receive a fixed rent check every month according to the signed lease and pay all debt services related to the lease.
Not All NNN Rentals Are Made Equal
I should mention that investors should be fully aware of the type of investment they are looking for. For example, many commercial brokers will market properties as triple net or NNN rental properties; however, the property can actually be either a NN or a double net lease. Please make sure and read the fine print of the lease and have your attorney look into it.
Finally, a net lease investment is the safest and most risk-averse commercial real estate investment on the market, due to the fixed lease, lessee liability, and most corporate warranties. However, make sure you contact a professional commercial real estate investment advisor, who can guide you through the entire process of acquiring and financing your net lease investment. Also, remember that commercial brokers are professional salespeople; therefore, it is wise for potential net lease investors to keep the services of a professional commercial real estate investment advisor working on their behalf. Typically, buyers are not charged a fee to maintain the services of a commercial real estate investment advisor who can act on their behalf with fiduciary responsibility to their clients, as would an attorney who will represent them in court. Thus, ensuring investors get the best possible deal by leveraging the strong negotiation skills of investment advisors, and reducing the hassles associated with purchasing a net lease commercial investment property.
