Properties with triple-net leases can be quite attractive to real estate investors, but they aren’t as straightforward as they might seem. Due diligence is critical, as changes often can’t be made once the lease has been signed.
The nuts and bolts
Under a triple-net lease, the tenant assumes responsibility of the property’s ongoing operating costs (taxes, insurance, maintenance) in exchange for a long-term lease. The tenant also pays the landlord monthly rent. The lease puts some limit on capital expenditures, usually triggered in the lease term’s final months.
Triple-net leases are used for a variety of properties, such as office, industrial and multiunit residential. For the latter, the landlord usually pays joint operating costs, and then invoices tenants for their pro rata share of the costs.
A property with a triple-net lease offers some advantages associated with a traditional real estate investment, such as appreciation and tax benefits, but many investors prefer triple-net leases because the leases allow them to avoid management responsibilities.
The leases can also provide long-term, steady streams of income similar to an annuity. They typically have a low tenant turnover rate, which helps reduce marketing and leasing costs. Often triple-net leases involve prominent anchor tenants, which increases predictability and lowers risk.
Because these leases are fairly stable investments, banks may offer sweeter terms, such as lower mortgage rates and down payments, than they give other types of real estate ventures.
Properties with triple-net leases are also good for property owners who want to sell existing properties and reinvest in a Section 1031 like-kind exchange to defer capital gains tax.
Like most real estate investments, triple-net properties have some drawbacks. In particular, inflation could create a nightmare if rent doesn’t keep pace with market rates. The effect could worsen if the tenant has options to extend a lease for additional periods, as option periods generally come with scanty rent increases. And good luck selling a property shackled with long leases and relatively low rents.
On the flip side, compare the rent to those for comparable triple-net properties to determine whether it’s currently above market, especially as the lease nears expiration. If you can’t obtain that rate in the future from another tenant, your net yield will likely drop.
Negotiate with care
A triple-net lease property can pay off as long as you negotiate carefully. In addition to the risks, bear in mind factors like your investment objectives and the tenant’s credit rating and likelihood of continued profitability.
For more information contact Denice Hertlein at [email protected].