Blog Post

Triple Net Leases

David E. Austin • Sep 05, 2018

Triple net leases (or "NNN leases") pass on the responsibility of the major costs of running a property on to the tenant, including taxes, insurance, and maintenance. The triple net lease can be advantageous to a tenant in that it lowers the rent payment, and may enable the tenant to cover the other costs more cheaply. For an investor, the triple net lease provides income without many of an owner's responsibilities and expenses that cut into their rental income.

Capital appreciation notwithstanding, taxes, insurance, and high maintenance costs (especially, in the case of the investor who buys units in residential condominiums in Hawaii, high condominium fees) can take such a huge bite out of rental income to make such a long-term investment a losing proposition.

With a triple net property, the investor is focused on the nature, quality and terms of the leases, rather than on just the capital appreciation of an asset. Therefore, it is vital to have counsel read and understand the terms of all of the existing leases during the due diligence period prior to investing in such an asset. The term "triple net" may be used by brokers when the leases don't really provide that taxes, insurance, and maintenance are all fully assumed by the tenant. In other words, what may be marketed as a "triple net" building may mean different things to different people; this is certainly true across the United States where various repairs may or may not be assumed by tenants, such as the replacement of a building's roof. The bottom line is that the leases must be read very carefully to ensure that they are, in fact, truly triple net.

Although there is significantly less hassle with a triple net property, as with any real estate investment, the triple net lease is not risk-free. The credit rating of the tenants, type of use, location of the asset, amount to be spent on tenant improvements, building condition, and, of course, lease terms should all be appropriately vetted during due diligence. That said, the triple net lease does provide many appealing features which routinely make them attractive investments.

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Cap Rates and Valuation

By David Austin • 05 Sep, 2018
When I was in graduate school at Johns Hopkins, our analysis professor, a successful commercial real estate developer in Baltimore, railed against cap rates. He believed that internal rate of return (IRR) was the only viable way to look at an asset's performance and we were told to stay away from the dreaded cap rate. However, cap rates are too prevalent in the industry to ignore, so it's important to understand what they mean and how they're calculated. A cap rate is, at its simplest, the ratio between net operating income and value of the property. It really is just a snapshot of the unleveraged rate of return on an investment for a single period in time. However, there are many variations of the cap rate. Most of the time, brokers and investors look at the "entry" cap at acquisition and the "exit" cap at sale, but you can also look at building, equity, mortgage, and land cap rates. However, cap rates are not all calculated in the same manner and do not account for certain important variables. For example, taking a cap rate from current rental income (relatively less risk) and extrapolating it to future income (more risk) may result in an artificially inflated value. Some analysts include replacement reserves and some do not. It also may not be accurate to compare the cap rate from a higher risk property (without ample reserves, solid management) with that of a lower risk property. The bottom line is when comparing cap rates, it is important to understand how the cap rate was calculated. It is good practice to consistently apply the same protocol internally when looking at cap rates to determine what adjustments may be necessary, and whether cap rates were calculated using similar methodologies.

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