Understanding Types of Net Leases
One of the steps to opening a brick & mortar vintage clothing store is finding a building to put your store in. Unless you own the said building you will most likely be renting the commercial space. This means that you will be required to negotiate and sign a lease/rental agreement with the property owner or property management company. There are a few different types of commercial leases out there and knowing your way around the terminology is your first step to making sure hat you do not get in over your head.
Once type of lease that you may run across is called a NET lease. In a net lease, the landlord charges a lower base rent for the commercial space, plus some or all of “usual costs,” which are expenses associated with operations, maintenance, and use that the landlord pays. These can include real estate taxes; property insurance; and common area maintenance items (CAMS), which include janitorial services, property management fees, sewer, water, trash collection, landscaping, parking lots, fire sprinklers, and any commonly shared area or service.
There are standard names in the commercial real estate industry for different sets of costs passed on to the tenant in a net lease.
Single net lease
In a single net lease (sometimes shortened to Net or N), the lessee or tenant is responsible for paying property taxes as well as the base rent. Double- and triple-net leases are more common forms of net leases because all or the majority of the expenses are passed on to the tenant.
Double net lease
In a double net lease (Net-Net or NN), the lessee or tenant is responsible for property tax and building insurance. The lessor or landlord is responsible for any expenses incurred for structural repairs and common area maintenance. “Roof and structure” is sometimes calculated as a reserve, the most common amount is equal to $0.15 per square foot.
Triple net lease
A triple net lease (Net-Net-Net or NNN) is a lease agreement on a property where the tenant or lessee agrees to pay all real estate taxes, building insurance, and maintenance (the three “Nets”) on the property in addition to any normal fees that are expected under the agreement (rent, utilities, etc.). In such a lease, the tenant or lessee is responsible for all costs associated with the repair and maintenance of any common area.
Triple net leases tend to be more landlord-friendly, and tenants should carefully review NNN fees and negotiate caps on the amounts they can be raised annually. An NNN lease can also fluctuate from month to month and year to year as operating expenses increase or decrease, making the company’s expense forecasting tricky and sometimes frustrating.
There are tenant benefits in the NNN leases, however. Transparency is an excellent perk, since tenants can see business operating expenses in relation to what they are charged. Cost savings in operating expenses are passed on to the tenant rather to the landlord. In addition, the monthly rent in a NNN lease is potentially lower than in a gross lease, as tenants have a higher level of responsibility for the building.
This form of lease is most frequently used for commercial freestanding buildings. However, it has also been used in single-family residential rental real estate properties.
A bondable lease (also called an “absolute triple net lease”, “true triple net lease”, or a “hell-or-high-water lease”) is the most extreme variation of a triple net lease, where the tenant carries every imaginable real estate risk related to the property. Notably, these additional risks include the obligations to rebuild after a casualty, regardless of the adequacy of insurance proceeds, and to pay rent after partial or full condemnation. These leases are not terminable by the tenant, nor are rent abatements permissible. The concept is to make the rent absolutely net under all circumstances, equivalent to the obligations of a bond: hence the “hell-or-high water” moniker. An example of this type of lease would be a leaseback arrangement in which a retailer leases back the building it formerly owned and continues to run the store.
Bondable leases are typically used in so-called credit tenant lease deals, where the main driver of value is not so much the real estate, but the uninterrupted cash flow from the usually investment-grade rated “credit” tenant.
This is a less common option that is more rigid and binding than the NNN lease, where tenants carry every imaginable real estate risk, for example, being responsible for construction expenses to rebuild after a catastrophe, or for continuing to pay rent even after the building has been condemned. Aptly called the “hell-or-high-water lease,” tenants have ultimate responsibility for the building no matter what.