The term Triple Net Lease (“NNN lease”) is frequently utilized in the commercial real estate context. So, what is a triple net (NNN) lease? Why is it so common? Does it favor the tenant or landlord?
What is a Triple Net (NNN) Lease?
A Triple Net (NNN) Lease is a commercial lease agreement in which the tenant agrees to pay a base rental amount and the net amount of the landlord’s real estate taxes, the net amount of the building insurance, and the net amount of the common area maintenance expenses. In practicality, almost all NNN leases look a bit different and allocate responsibilities between landlord and tenant in slightly different manners. Because of the variations, it is crucial that a tenant pay close attention to the NNN lease proposed to them by a potential landlord.
Does a Triple Net (NNN) Lease Favor the Tenant or Landlord?
With a NNN lease structure, almost all responsibilities fall on the tenant versus the landlord. The tenant will be responsible for paying rent as well as the landlord’s direct overhead associated with owning the property (taxes, insurance, operating expenses, utilities, etc.).
If you think this sounds very favorable to the landlord then you are right, it is! So why should a tenant agree to this? The tenant’s ability to negotiate around a NNN leases is typically limited by the particular geographic area. In many areas, it is common practice to require a NNN lease if a tenant wants to lease commercial property. In other areas, especially in smaller cities, it may be less common to utilize NNN leases.
Does this mean a tenant has no room to negotiate more favorable terms? Absolutely not! There are many areas where a tenant can negotiate a NNN lease to make it more favorable.
First, the base rental amount becomes a key negotiating term. If the tenant is taking on all responsibility and risk of the landlord’s overhead, then the tenant may be able to negotiate a more favorable base rental amount.
Second, NNN leases can vary in the particular items included as part of the overhead. Frequently, tenants can negotiate that the landlord remain on the hook for certain repair costs and/or utilities
Why are Triple Net (NNN) Leases so Common?
Landlords prefer NNN leases because they remove some of the unknown financial risk related to commercial property. If taxes or insurance increase, or if unexpected maintenance costs are incurred, then the tenant is on the hook to bear the burden of the additional expense. This is good for landlords and especially nice for investors.
What Should a Tenant Watch Out For?
If overhead (taxes, insurance, maintenance, etc.) is prorated amongst multiple tenants, then it is important to take a close look at the calculation. Is the proration based upon leasable space or occupied space? The latter could be devastating to a tenant. For example, if five tenants in a five-unit commercial building split the overhead equally, everything is fine until 3 tenants vacate the property, leaving only 2 units occupied. If taxes, insurance, maintenance and utilities are prorated based upon occupied space then the 2 remaining tenants must now split everything 50/50. Not good!
If overhead is prorated based upon leasable space, then it is important for a tenant to pay close attention to the definition of “leasable space” – does it include space that is available but not yet built out? For a tenant, you want to make sure it includes the entire building no matter the condition or intent of the landlord to utilize other portions of the building.