Triple Net Lease Agreements

What Does Triple Net Lease Mean?
A lease contract that requires the lessee (tenant) to pay all ongoing expenses, viz. property taxes, building insurance and the cost of common area maintenance, in addition to paying a regular rent is known as a triple net lease agreement. Utilities and the cost of repairs also have to be borne by the tenant. By definition, the triple net lease structure requires the lessee to pay the net amount of property taxes, building insurance and cost of common area maintenance. Hence, the lease is also known as net-net-net lease or NNN. As against tenants' commitments, landlords are only responsible for the roof and the structure of the leased property and may occasionally be expected to pay for parking.

It's evident that triple net lease agreements are not meant for residential properties since the landlord has virtually no responsibilities. The tenant has to pay the amount of rent in addition to a number of other expenses that are normally borne by the landlord in a standard residential lease agreement.

How Does a Triple Net Lease Work?
Commercial triple net lease agreements have become popular on account of a number of advantages that accrue to the lessee as well as the lessor. Typically, NNN leased properties are single-tenant retail properties although the leased asset may be used as a single tenant office or an industrial building. Businesses have a number of commercial leasing options of which NNN is popular on account of the following reasons:

Advantages of Triple Net Leasing: The lessee is a corporate entity that has a high credit rating and is interested in leasing the property for a period of 10 to 25 years. A high credit rating reduces the chances of default and ensures that the lessor receives a steady stream of income without having to bear the cost of operating expenses and capital improvements. These corporate entities make great tenants who maintain the property in a manner that befits their corporate image.

In order to apply for a commercial loan (for triple net financing), one needs to be aware of the lease rate. The lease rate is quoted in dollars per rentable square foot. It can be determined by working backwards from the value of the property and assuming the cap rate and adjusting the net operating income to arrive at the annual gross income of the rental property.

REITs are good investments for people, with limited capital, who are interested in long term secure investments that yield a steady source of income. Moreover, the credit worthiness of the tenant reduces the chances of default.

The lessee also benefits from commercial triple net lease agreements since the tenant can retain control of the asset without actually owning the same, thus reducing the required capital investment. The tenant thus saves on real estate venture capital that can be used for other purposes.

Triple Net Lease Disadvantages: Although, the lessor of triple net lease properties is entitled to receive a steady income in the form of rent, the rent is at best inflation adjusted. In other words, the rent of comparable properties may increase at a faster pace as compared to the rent of triple net lease properties.

While calculating depreciation for residential rentals, the asset is depreciated over 27½ years. Triple net lease properties, on the other hand, are commercial properties that have a depreciable life of 39 years. In other words, the tax shelter for residential rentals is much higher than that of commercial rentals.

Triple net lease (investments) properties are good investments for people who are willing to forgo some amount of liquidity in exchange for a steady stream of income. This is because commercial properties are much harder to lease as compared to residential properties and a long term vacancy, on account of a slump in the market, will have disastrous consequences for investors with less liquidity.

Calculating Present Value of the Real Estate Investment
Prior to investing in real estate, investors should determine the value of the income generating property. This is done by using the capitalization rate or the cap rate and determining the present value of the investment. The cap rate is inversely proportional to the term of the triple net lease and the credit worthiness of the tenant. The present value calculation for triple net lease properties is as follows:

Present Value of the Real Estate Investment = NOI / Cap Rate

NOI = Gross Income - Vacancy and Collection Costs - Replacement Reserves

For better explanation on NOI, investors/buyers may refer to the article, 'How to Buy a Rental Property'. Lessors and lessees should take a look at free-triple net lease agreement documents before deciding on such an agreement. Although, the Internet is the primary source of free information, the chances of stumbling upon a free triple net lease template is extremely rare. A number of websites, however, allow the user to download sample triple net lease agreements for a nominal price. It would be prudent to consult an expert for additional details regarding triple net lease terms.