Net Lease Explained
If you’re in commercial property, you’ve probably at least heard the term net lease, but if it’s not something that you have dealt with firsthand, you may not know what it means - yet. Chances are, you will need to become familiar with the concept at some point, and that’s what we’re here for.
Since we have an entire team specializing in providing transactional and advisory services for net lease properties, they will be filling you in every month as part of our Net Lease Explained series. That team is made up of brokers Deuce Harris II, Graham Storey, and Charles Bartscher. Deuce and Charles start us off by answering questions about what net lease is and why it’s beneficial for both a property owner and a tenant.
Pickett Sprouse: What is net lease?
Charles Bartscher and Deuce Harris II: Net lease is basically a contract agreement where a lessee pays all or part of the owner’s property expenses in addition to rent. Depending on the type of net lease it is, this could include the landlord's taxes, insurance fees, and maintenance cost of the property. In essence, each type of net lease takes away some level of risk from the property owner.
PS: What are the different types of net lease?
CB & DH: There are three different types. You can have a single net lease, a double net lease, or a triple net lease.
Single net lease
A single net lease is when the tenant pays the landlord's property taxes. Depending on the contract and the tenant, either the tenant will pay for the taxes directly or the landlord will pay the taxes and the tenant will then reimburse that later on.
Double net lease
A double net lease is where tenants will pay the property tax and insurance premiums in addition to the rent. This is very common in commercial real estate.
Triple net lease
There are different degrees of triple net leases. They range from absolute, where the tenant pays all responsibilities of ownership, to where the tenant only pays a majority of the taxes or the costs of ownership up to a certain amount. For triple net tenants, this is expressed in terms of being responsible for TICAM, which stands for taxes, insurance, and common area maintenance.
PS: If there are multiple tenants, how does a net lease work?
CB & DH: Depending on the type of net lease, taxes, insurance, and maintenance costs are assigned proportionally to the amount of space that the tenant is leasing. For example, if there are three tenants with each tenant using 33 percent of the building, a $3,000 property tax bill would cost each tenant $1,000.
In most cases, if there are multiple tenants, the owner probably has a property manager that oversees and collects all of the different payments. In some cases, the building owner may serve as the property manager.
PS: What is the benefit for a tenant to do a net lease instead of a gross lease?
CB & DH: In a gross lease, the base rent is higher because it incorporates not only the use of the space itself but all of the known and potential costs associated with operating the property. A net lease is beneficial to a tenant because the base rent is usually lower. While the tax and insurance costs are generally known, other maintenance costs may or may not be a factor depending on the condition of the building. Tenants can also itemize each expense, so it helps to offset their gross income. An additional benefit for tenants is that they can lock in a lower base rent rate for a longer period of time.
PS: What is the downside to a triple net lease for the property owner?
CB & DH: As a property owner, you want to make sure that you have a credit-rated or credit-worthy tenant. In other words, someone who is going to keep their side of the agreement or care if they break the lease. If that doesn’t happen, the property owner can be left with a large expense.
Another potential downside is that since triple net lease agreements are usually for 10-15 years, you’re not going to see a lot of, if any, rate increases for strong tenants during that time. The benefit in that situation is that you’re going to have regular cash flow for a long period of time, but it comes at the expense of not being able to raise the rent based on the demand for the location or to keep up with inflation.
PS: What are some of the most common businesses that do a triple net lease?
CB & DH: Many of the strong national chains that need a specific type of space do a triple net lease. Those include Dollar General, Walgreens, KinderCare, etc.
PS: Are all net leases fairly straightforward and simple?
CB & DH: No! Contracts come as different as the companies that are the tenants. While net leases can provide a steady stream of income for a property owner, there can also be a lot of variables in the terms of the contract, in being able to identify a quality tenant, and in recognizing the potential pros and cons of a location and what that will mean for your investment. That’s why it is important to have knowledgeable and experienced net lease advisors like the Pickett Sprouse team working for you.
Ask a Net Lease Question
Our brokers will be answering your questions every month through the Net Lease Explained series. If you have a net lease question, our team wants to hear from you at email@example.com.