Hey there, 👋 Mo here.

Today, we’re doing a deep dive about “passive income”, the holy grail all real estate investors want.

Triple Net Leases: Ultimate Guide for Commercial Property Investors

We will cover:

• What is a Triple Net Lease?

• The Allure of Triple Net Lease Investing

• The Drawbacks of NNN Investing

• Conducting Due Diligence on NNN Deals

• Opportunities Within NNN Investing

What is a Triple Net Lease?

A triple net lease, or NNN lease, is a net commercial lease where the tenant pays their share of base rent plus all real estate taxes, building insurance, maintenance, utilities and other operating costs for the property.

Comparing NNN, NN, and N Leases

When looking at net leased commercial real estate, investors will encounter NNN, NN, and N leases. What's the difference between these three net lease types?

Triple Net (NNN) Leases

This is the most popular net lease for commercial properties. In a triple net lease, the tenant pays base rent plus all operating expenses including:

- Property taxes

- Property insurance

- Maintenance and repairs

- Utilities

The landlord has minimal responsibilities besides major capital repairs like replacing the roof. The tenant handles all other operating costs.

Double Net (NN) Leases

In a double net or NN lease, the tenant is responsible for both property taxes and property insurance in addition to base rent. The landlord covers all maintenance and repairs.

An NN lease puts more operating expense burden on the landlord than an NNN lease. The tenant does not deal with maintenance duties.

Single Net (N) Leases

Under a single net or N lease, the tenant only pays the property taxes in addition to rent. The landlord handles insurance, maintenance, repairs, and other building expenses.

This is the least common net lease type as it transfers the most operating costs to the landlord. The tenant has the fewest additional expenses beyond base rent.

NNN leases place the maximum operating expenses on the tenant, while N leases minimize the tenant's costs beyond rent. NN leases are in the middle.

Types of Properties that do NNN leases

While any type of commercial real estate can utilize an NNN lease structure, certain property types are especially well-suited and commonly structured as NNN investments:

Retail Properties

Retail stores, restaurants, banks, and pharmacies like Walgreens often favor NNN leases. They want to lock in fixed occupancy costs and avoid variable landlord expenses. Retail accounts for an estimated 80% of NNN leased properties.

Healthcare Properties

Doctor's offices, urgent care clinics, and medical buildings lean toward NNN leases to control facilities costs as part of their budgeting. Healthcare makes up around 10% of NNN deals.

Industrial Properties

Warehouses, distribution centers, R&D flex spaces also commonly carry NNN leases, especially single tenant buildings. The fixed expenses aid user budgeting.

Office Spaces

While less common than other property types, office buildings or corporate HQs may use NNN leases, especially for call centers or data centers focused on controlling costs.

The Allure of Triple Net Lease Investing

NNN investments are essentially clipping coupons with real estate.

- Extremely passive investments - The landlord simply collects net rent each month with no maintenance duties. This means no calls at 2am from tenants.

- Lengthy lease terms - National retail chains like Walgreens often sign 10-20 year initial NNN leases to lock in fixed occupancy costs. Don’t need to worry about vacancy.

- Built-in rent increases - To keep pace with inflation, NNN leases generally have pre-defined 3-5% rent bumps every 1-5 years. This is negotiable and depends on your lease.

- Lower operating expenses - With the tenant paying taxes (~1.25% of property value), insurance (~0.33% of value), maintenance and other costs, expenses are minimized.*

- Recession resilience - Creditworthy NNN tenants with long leases can continue rent payments even when other businesses fail in economic downturns.

*Depends on wide variety of factors

The Drawbacks of NNN Investing

However, NNN leased properties also come with risks and downsides:

- Limited appreciation potential - With fixed lease rates, there is little room for upside from property value appreciation. At renewal, base rents often just rise to market levels.

- Lack of landlord control - The tenant makes all decisions about maintenance, operations and expenses. This could mean subpar construction work if tenant chooses lowest quality contractor.

- Heavy reliance on the tenant’s financial health - If the tenant goes under or defaults, the landlord suffers greatly. Carefully evaluating the tenant is key.

- Tenant-specific spaces - As many NNN properties are customized for tenants, re-leasing can be very difficult if the tenant vacates. For example, a restaurant space.

- Lower leverage - Some lenders limit LTV ratios on NNN deals to 60-70% given the perceived riskiness.

- Potential for expense abuse - Tenants may take liberties and overcharge on maintenance and repairs paid out of NNN funds.

-Buildouts cost money - tenant improvements (TI’s) are often done to entice tenants to build a space to their liking. Usually a mixture of landlord and tenant share the financial responsibility. If you rent to an unqualified tenant and they default within 2 years of a 5 year lease, you have to spend more $ on TI’s to re-lease it to a different space.

Conducting Due Diligence on NNN Deals

Because NNN properties depend heavily on the tenant, extensive due diligence is a must before investing:

- Carefully review the full rent roll and lease agreements for terms, renewals, and exclusivity clauses.

- Thoroughly analyze the financial statements, profitability, and creditworthiness of the tenant. Be particularly careful with mom and pop shops.

- Inspect the real estate or order third-party inspection reports to assess the condition.

- Verify conformity with zoning regulations, building codes and other requirements.

- Compare asking rents and the purchase price to area comps to gauge value.

- Review estoppel certificates, SNDAs and other critical documents.

Opportunities Within NNN Investing

There is still some value to be found. Just like everything, it depends on your “cost basis” or the amount of $ you spend on a property.

Upgrading Facilities

Some properties may have outdated interior finishes or aging systems. If permitted by the lease, the investor could offer to refresh common areas, bathrooms, HVACs, etc in exchange for higher rents. Tenants often embrace operational upgrades as it looks good to retail tenants.

Lease Renewal Renegotiation

Upon lease renewal, there could be an opportunity to negotiate higher base rents by voluntarily upgrading facilities or agreeing to new lease terms. Market rents may have risen since the initial lease was signed.

Sale-Leasebacks

With high property prices and limited supply, some businesses are now opting to sell company-owned facilities and lease back the space. This creates a chance for investors to acquire NNN properties.

Distressed Assets

The 2020-2022 downturn increased distressed opportunities as some tenants failed. Investors may buy properties below market value and find new tenants.

Subleasing Rights

Seeking leases with transferability or subleasing rights provides flexibility to rent vacant space to new tenants if the existing tenant vacates.

Combining subleasing with marketing those leases at current market rents could provide to be a value-add for your property.

The Bottom Line

In summary, NNN leased properties offer stable, consistent cash flow for hands-off real estate investors. But significant due diligence is required to evaluate tenant risk and the potential for appreciation. Investors must weigh if the limited upside potential of NNNs aligns with their return goals and risk tolerance.

Let me know if you would like me to modify or add any additional details to this draft newsletter article! I'm happy to reiterate it further.