Triple-Net Leases Can Provide Long-Term Stable Cash Flows

triple-net leases

Triple-net leases are popular with core investors seeking a long-term stable cash flow. Triple-net leases typically stipulate that the tenant is responsible for paying not only a monthly rental rate but also the property tax bill, the property insurance premium and maintenance expenses. Triple-net leases are typically used for commercial buildings and are often referred to as NNN leases. However, some costs, such as property management fees and other expenses associated with leasing the property may be covered by the landlord (Geltner, Miller, Clayton and Eichholtz, 2013).

Some triple-net leases may include a stop clause, which determines an operating expense amount, which serves as the maximum operating expense that will be paid by the landlord. Any amount above that will be paid by the triple-net lease tenant.

Advantages of Triple-Net Leases

From a property investment point of view, properties leased to credit tenants with long-term triple-net leases offer the following investment advantages:

(1) Stable and predictable long-term cash flows with very little uncertainty

(2) Very little property management responsibilities, since the tenant is responsible for the proper maintenance of the space rented, especially in the case of single-tenant buildings

(3) Possibility for capitalizing on long-term increases in market rents that will push property value up, while enjoying a stable cash flow

(4) Protection from market rent declines due to the long-term leases, at least in terms of the income earned by the property (it does not protect the property investor from decreases in value, especially when the remaining term on the lease is below ten years).

(5) Partial or full protection from inflation depending on how the rent escalation clauses relate to inflation (D. Reynolds, 2017)

 

Disadvantages of Triple-Net Leases

Properties with triple-net leases have though and some disadvantages from an investment point of view:

(1) Usually, they offer a low income return. Because the cash flows of these properties have little uncertainty, the investors need to accept low going-in cap rates (see our post on Going-in Cap Rate for a more detailed discussion) and pay higher acquisition prices that allow for lower income return, perhaps 4-6%.

(2) Inability to take advantage of potential strong increases in market rents that may take place during the long duration of the lease

(3) Since the cost of maintaining the space rented falls with the tenant, the tenant may not appropriately maintain the building in order to reduce costs

 

Conclusion

In sum, properties leased with long-term triple-net leases to strong credit tenants could be suitable investments for investors interested more in a stable long-term income return and care less about capital gains (increases in the value of the property). Also, they are suitable for investors seeking low-risk investments. Furthermore, their inclusion in a real estate portfolio can help reduce portfolio risk from market fluctuations.

 

References

Kolbe, P. T., & Greer, G. E. (Author), Gaylon E. Greer.  (2012). Investment Analysis for Real Estate Decisions, 8th  Edition. Dearborn Real Estate Education.

Sivitanides, P.  2008. Real Estate Investing for Double-Digit Returns. BookSurge Publishing.

Geltner, M., Miller, N. G., Clayton, J., & Eichholtz, P.  (2013). Commercial Real Estate Analysis and Investments (with CD-ROM). Oncource Learning

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Author: Petros Sivitanides, Ph.D.

Dr. Sivitanides is a seasoned expert in real estate investment strategy and analysis, property portfolio modeling and strategic analysis, and real estate market research and econometric forecasting with over 16 years of experience with leading global real estate investment managers and real estate consultants (CBRE Global Investors, AXA Real Estate, Torto Wheaton Research, DTZ, etc.). He is the editor of the textbook titled “Market Analysis for Real Estate”, which has been used as the main textbook for a graduate course at Harvard University. He is also the author of the book "Real Estate Investing for Double-Digit Returns" and many widely quoted articles that have been published in popular real estate journals. Currently, he is the Head of the Real Estate Department at Neapolis University in Cyprus, and an international real estate consultant.

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