Triple net lease. NNN. Absolute net lease. All of these are different ways of saying the same thing. These refer to leases that require the tenant to pay for three important things: taxes, insurance, and repairs. But, these terms get thrown around as if there is an exact definition for each, which is not the case. Sometimes, as is the case with many new buildings, a triple net lease requires the tenant to pay for external parts of the building like the roof or the mechanical systems while others only make them responsible for “inside the walls” of the space they occupy. Even though there is a variety of different iterations of the idea, the category as a whole is an important part of the commercial real estate stock.
First, this is a very large part of the asset class. A CBRE report from April 2018 showed that the yearly investment in U.S. triple lease properties had risen to $57.8 billion. They are also a great entry point for many investing in commercial real estate. They represent the type of passive income that many are looking for in a real estate investment since they require little to no work for the owner. This is likely why the CBRE report also identified that foreign buyers have increased their holdings of triple net properties more than any other investor group. If you want to diversify a real estate portfolio with properties from various markets, NNN properties are a great way to achieve that.
Triple net leases often have only one tenant and have long lease terms. Most large chains like fast-food restaurants or grocery stores prefer to have a triple net lease. This means that triple net properties are often some of the least risky. Long leases mean that vacancy risk is low and delinquency is protected by the cash flows of large businesses rather than small ones. A large corporation can often absorb a downturn better than a local business (although it should be said that even they can find themselves in hard times, just ask someone that used to rent to Marie Calendars or Payless Shoes). Having one tenant also makes the valuation of the building much easier. Rather than having to merge the value and risk of multiple tenants, each with their own terms, only one cash flow needs to be considered for the cap rate. These factors are likely why triple net properties often have higher cap rates than their gross or hybrid lease comparables.
Even if you are sold on the idea of investing in a property with a triple net lease, there are important things to consider. First is the strength of the tenant. As mentioned earlier many previously profitable retail companies are struggling in the era of e-commerce. Due to changes in technology and society what might have been a good business model for the last thirty years might not be sustainable for the next five. It isn’t just your tenant that you need to worry about either. If the area is suffering even the best tenants will struggle. This is especially true for “strip mall,” which usually have triple net properties. Most of these shopping centers have an “anchor tenant” like a large retailer or big box store. If the anchor tenant leaves or goes out of business it will be detrimental to the entire center. Many smaller stores have no choice but to leave a shopping center once the anchor tenant leaves and takes their foot traffic with them.
Many people that want to buy a commercial property are looking for a secure, hassle-free investment. For them, a triple net leased building represents a great example of that. They can create a reliable cashflow while building equity in the building itself. Owners don’t have to worry about insurance escalations or unscheduled maintenance expenses. But, even though triple net leases are some of the most secure options when it commercial property, they do not come without risk. Before committing to any purchase investors should do their homework including actual lease terms, tenant strength, and local market forecasts.