Net Leased Investments – also called NNN, Net-Net-Net or Triple Net – are commercial real estate investments where all or most of the property-related obligations are the tenant's responsibility. NNN are common throughout the United States; the type of net lease defines the contractual obligations of the lessor (owner, landlord) and the lessee (tenant).
Below please read in more detail about:
Types of Net Leases
Types of Net-leased Properties
Investment Volumes and typical Returns
Risks and Security
TYPES OF NET LEASES
The most common lease types are:
Single Net Lease: Lessee pays a monthly base rent and property taxes. The owner is responsible for all other operating expenditures of the property.
Double Net Lease (NN): Lessee pays a monthly base rent, property taxes and property insurance. The owner is accountable for all other operating expenditures of the property. There are certain NN leases which split the maintenance responsibilities between lessor and lessee; for example: lessee pays all inside maintenance, lessor pays for roof and structure maintenance.
Triple Net Lease (NNN): Lessee(s) pays a monthly base rent, property taxes, property insurance and all maintenance. In a NNN lease, there may be several legal protective clauses which could release a lessee of his obligations. For instance, a triple net lease may release the lessee of his accountability if the property is subject to an eminent domain procedure.
The landlord's benefit: the net lease structure creates a steady and predictable cash flow, and makes the investment ideal for investors who are absent or who do not want to be involved with property management.
The tenant's benefit: it allows use of one or many properties without acquiring them, often at favourable rent rates since the tenants are taking on extra cost.
Critical to a successful net-leased investment are the location, the quality of the tenant and, to a certain extent, alternative use options in case the tenant vacates or defaults.
TYPES OF NET LEASED PROPERTIES
Industrial: local, regional or national tenants such as FedEx, manufacturers or distributors.
Restaurants: fast food such as Burger King, McDonalds, Taco Bell or Dunkin Donuts. Also Quick-serve restaurants such as Chili's, or sit-downs such as Macaroni Grill etc.
Retail: regional or national tenants such as Target, CVS, Walgreens. Also Office Depot, Staples or Sports Authority ("big box" retailers). Includes sub-types such as Automotive and Banks.
Office: buildings with single or multiple local, regional or national tenants, often service providers such as medical offices, law firms, accountants, dialysis providers etc.
INVESTMENT VOLUME AND TYPICAL RETURNS
Depending on the area, solid NNN investments can sometimes be found as low as approx. US$800,000. Typical prices are more likely to start around $1m and can exceed $80m for single properties, more for portfolios of investments.
NNN properties may be purchased by an individual or by a group of investors, basically forming a closed fond. In either case, sound legal and tax advice are an absolut must before entering into a Letter of Intent or a contract.
Returns (or 'cap rates') currently range from approx. 4.0% p.a. for strong tenants up to perhaps 7.0 percent for local, lesser known or less solid tenants, and/or remaining lease terms of only a few years. As market demand is currently increasing (Q3 2021), prices are slowly rising, resulting in slightly decreasing cap rates, at times even under 4.0 percent.
NNN investments can typically be financed, the lot plus improvements and the income stream being the collateral against the loan. Loan conditions depend on the location, property value and stability of the tenant. Because of these variables, it is impossible to quote a range of terms on this page.
Trophy properties and/or trophy states such as Florida often demand higher prices and thus lower cap rates, due to higher demand or perceived image gain. Such a trade-off has to be decided by every investor according to his/her preferences, asset diversification plans and investment goals.
Possible property appreciation is never included in cap rates and may be calculated separately (IRR or Internal Rate of Return). How precise and realistic an IRR can be calculated into the future can of course be debated.
RISKS AND SECURITY
As it is common in all capital- and investment markets: the safer the investment, the lower the return. There is no such thing as the Swiss Army Knife of net-leased investments, combining every owner's benefit with an astounding cap rate and a rock-bottom purchase price. Do not be tempted by unrealistic promises: Caveat Emptor.
That said, two riskfactors are relevant for a purchaser:
1. Loss of the property (flood, fire etc). These risks are insurable and are to be covered by the tenant. 2. Loss of rent, or even loss of the tenant (the property is “going dark”). These risks can hardly be completely eliminated, but they can minimized (and also insured): A) By careful tenant selection. A brand such as Burger King will grant 30, 50 or more concessions only to the strongest franchisees. Non-franchised tenants ought to be evaluated by their financial strength and operating history, to ensure one has a reliable partner for the next 10, 20 or 30 years after purchase. B) By careful evaluation of the alternative use of the property, should it become a necessity. An example: Checkers Hamburger locations always construct a building with the smallest possible footprint and do not offer any inside seating, only outside. Therefore, a former Checkers location is hardly usable by other burger chains or quick-serve restaurants. Consequently, finding an alternative use of a Checkers property might become problematic should the operator default.
Security for the investor consists of these three components:
1. A strong and proven tenant – see paragraph 2a above. 2. Property ownership. The purchaser will be recorded and titled as the registered owner of the property, in a form most advantageous to him from a legal and tax perspective (LLC, corporation, trust etc.; see Guide to US Real Estate Transactions.) Thus the purchaser enjoys all rights of real estate ownership in the US, especially the right to mortgage, the right to sell and – in addition to the regular income stream – the rights to a possible appreciation. Note: with a ground lease the purchaser only acquires the use of the property for a specified number of years, but he/she is not the owner of the underlying real estate. After a specified number of years, all rights revert back to the original owner. Therefore, some of the essential privileges of ownership are not available to the investor. 3. Alternative use, for the worst-case-scenario of a tenant vacating without fulfilling his rental obligations (note: there are "dark" properties where the tenant continues to fulfill all obligations, he just stopped operating in this location).
Liquidity of a NNN-investment: an important drawback in real estate ownership – lack of liquidity due to an often-lengthy sales process – is largely mitigated with Triple-Net investments, due to two factors: (1) offered for sale is not only a lot with improvements (buildings), but also with a return ("cap rate") on investment based on a predictable income stream. (2) Through the offered cap rate, the seller can influence the timing of the sales process and speed it up if needed.