Triple net NNN leases seem to be all the rage for real estate investors.  Real estate investors exhibit significant interest in triple net leases for several reasons. The “passive” income strategy enables the acquisition of lucrative commercial real estate without confronting the complexities associated with property maintenance and management. Automate your triple net property management to facilitate a swift initiation. Advance with confidence: 1) Acquire a property with a triple net lease; 2) Execute a profitable leasing agreement; and 3) Observe the substantial rental income deposited into your bank account monthly.

Investing in commercial real estate is inherently complex, and reality often surpasses fantasy. Investors, landlords, and asset managers must maintain vigilance and possess a thorough comprehension of the numerous complexities and uncertainties that may present issues in any commercial transaction, irrespective of its classification as a triple net lease. The reality is clear: triple net leases are seldom as unequivocal as they first seem. Investors and landlords engage in commercial property investments with specific expectations concerning project outcomes, often relying on data that is only partially correct and supplied by the present owner or asset manager. Nonetheless, concealed expenses or unforeseen complications can adversely affect those estimates, potentially converting a financially advantageous agreement into a catastrophe. An investor must allocate sufficient time and resources to meticulously examine the lease and confirm that its conditions align with the business arrangement’s expectations. The investor must undertake interviews and interrogations with all principals involved in the transaction and secure the receipt and analysis of all existing audited paperwork and estoppel certificates.

What is a Triple Net Lease and Why are they Desirable?Understanding the Triple Net Lease Structure and Understanding the Benefits of a Triple Net Lease

I would like to remind you of the specifics of a triple net lease. If you pose that query to five distinct individuals, it is exceedingly probable that you will receive a diverse array of responses. The vast majority of commercial real estate brokers will agree that a triple net lease is a real property lease in which the tenant is responsible for all expenditures, including the maintenance of common areas, taxes, property insurance, and utilities, in addition to the base rent. The agreement specifies that the landlord is not liable for any out-of-pocket expenses or is reimbursed for them, with the exception of the costs associated with the building shell and exterior.

Significantly, investors in 1031 tax-deferred transactions are considering triple net leases as a potential investment option. A 1031 exchange, often known as a “like-kind” exchange, allows you to use the proceeds from the sale of one investment property to buy another of equal or greater value. This permits owners to defer payment of capital gains taxes payable on the initial sale of their investment property. Alternatives to complying with the Internal Revenue Code’s requirements include reverse exchanges or exchanges in which the buyer modifies the cash or mortgage involved in the transaction. In an ideal world, a triple net lease would allow investors to store their funds in a property without (in principle) needing to actively manage it. Most likely, the investors already have a skilled property and asset management team in place.

Coy and Clever Hidden Lease Language Should be Understood

In a perfect scenario for a landlord or investor, a triple net building or property is an investment in which the landlord or investor has largely eliminated out-of-pocket costs associated with the building or property. On the other hand, there are seemingly limitless fact patterns that can give rise to situations in which the owner’s objective of a hands-off investment can be flipped upside down. As a result, it is of the utmost importance that each and every lease be comprehensively examined over the duration of your due diligence in order to identify potential areas of exposure to hidden costs. Just a few instances are provided below.

Example One: a lease is promoted as triple net because the tenant is responsible for doing common area maintenance on the property. This can include snow removal, upkeep of the parking lot, maintenance of the outside landscaping, and providing for routine repairs to external components that are open to the public and other tenants. Within the same lease, there is a condition that directly obligates the landlord or investor to either repair or replace the roof or structural components of the building in the event that it becomes essential, or to contribute in the event that capital repairs are required. These are expensive items, and if a landlord is required to pay for them out of their own pocket, it has the potential to substantially alter the economics of the investment.

Example Two: other leases may require the landlord or investor to make significant capital investments for the purpose of replacing the roof and/or the HVAC equipment. However, the tenant is only required to replenish the landlord/investor costs on an annual basis, and the amount that they are required to replenish is proportional to the amount that the landlord/investor is permitted to depreciate the capital improvement according to the regulations of the Internal Revenue Code.

Example Three: is a reciprocal easement agreement, which is also referred to as a declaration or covenants, conditions, and restrictions (CCR’s). These agreements encumber the land as well as the properties that are close or next to it. It is common practice for multi-parcel developments to involve the formation and recording of reciprocal easement agreements. Whenever parcels are sold, ownership of the parcels is transferred to other parties. It is common for retail complexes and mixed-use projects to include land-based agreements like these. These agreements cover a wide range of topics, including usage limits, building and construction restrictions, and utility easements. Under the terms of reciprocal easement agreements, property owners are often required to make a contribution toward the costs of maintaining sections of the development that are located outside of the boundaries of their direct property. In the event that the triple net lease that the tenant has on that property (which is burdened by the reciprocal easement) is not properly drafted and/or does not explicitly obligate any tenant to pay or reimburse the costs that are borne by the reciprocal easement agreement, the landlord/investor will continue to be obligated to pay those funds.

Example Four: the terminology used in the field of triple net leases differs significantly from that used in the domain of performance and reimbursement. Many leases are touted as triple net because the tenant must compensate the landlord for the costs of common area maintenance (CAM), property tax, and insurance. In some circumstances, this action is undertaken on a monthly, quarterly, semi-annual, or annual basis, with a reconciliation audit conducted at the end of the year. Despite the fact that the landlord is compensated for every dollar spent on the building or property, the amount of time, effort, energy, and money required to administer these assets prior to getting payment is not always taken into account. The landlord or investor will need to spend time looking for contractors, billing them, calculating reconciliations, collecting payments, and performing other related tasks. More complicated NNN contracts have built-in cost reimbursement components that tenants must bear. These cost components include property management and accounting fees, which should cover CAM administration expenses and make the landlord/investor whole.

Read the Leases Before You Close Escrow

When it comes down to it, not all leases are the same. Triple net leases have the potential to be the lucrative investments that they are frequently promised to be, with low to no active duties on the part of the landlord/investor. This is something that cannot be denied. At the same time, it is not possible to foresee every single aspect of the future in regard to a building, its tenants, and the entire world. In spite of this, it is of the utmost importance that commercial investors in this industry carry out a comprehensive review of the lease language during the period of their due diligence. Additionally, it is essential that they have professionals working (asset and property managers) on their team in order to guarantee that there are no unanticipated circumstances that could negatively impact the perceived value of the transaction. Because after all, the truth is stranger than fiction.

David Roberson
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