What Is an NNN Contract?
NNN contracts are leases that place a minimal amount of responsibility for property maintenance on the landlord. Other than for issues which involve the common areas or structural elements of the property, it is primarily the responsibility of the tenant to ensure the safety and usability of the premises.
Specifically, among other things, the tenant is responsible for paying property taxes, property insurance and other costs associated with property use.
With NNN contracts, the tenant pays a single monthly rent amount which includes all these costs. They are thus "Triple Net" leases because the net returns to the landlord are calculated after taking into account all of these costs. In a way, NNN contracts are similar to the NNN contracts we see in the housing market, but with commercial leases.
While NNN contracts are similar to standard gross leases or simple leases, they do have important differences. Commercial leases vary in their length and the degree to which the business owner accepts responsibility for certain business expenses. For instance, some commercial leases do not require tenants to pay property taxes. Such leases are called "gross leases." Where the tenant pays only the base-level rent a property owner specifies within the lease , they are "simple leases."
Generally, NNN contracts carry greater accountability and transparency than similar gross leases or simple leases. However, this increased complexity can also appear intimidating and daunting to tenants.
Because NNN contracts exist in an industry with a unique set of standards and procedures, parties who are new to NNN contracts may find themselves confused by the many rules and regulations that NNN contracts delegate responsibility of a property’s daily operations.
To the untrained eye, NNN contracts seem even more complex because they are often many pages long and contain dense legalese that obfuscates the true meaning of certain terms.
One important point to note is that NNN contracts are different from ground leases or GLA leases (ground, land, or ground lessee). Ground leases involve much greater responsibility on the part of the tenant. While NNN contracts are concerned mainly with property ownership costs, ground leases are designed to cover development and planning costs such as architectural or use-planning costs.
The lease term is a significant component of NNN contracts. Most NNN contracts last somewhere between 15 and 25 years, though some last longer than that. In many cases, the contracts grant tenants an option for extending the lease term.
How a NNN Contract Benefits You
For landlords and tenants alike, the most apparent benefit of the triple net lease arrangement is cost predictability. Unlike gross leases—where tenants pay a flat rent and landlords are responsible for all costs for property management, maintenance, and taxes—the triple net lease agreement provides for a system of stable property expenses for both parties. For the duration of the lease, the tenants will be responsible for their share of taxes, property management costs, insurance coverage, and more. These costs are typically assessed on a pro-rata basis, so the more space a tenant occupies within the property space, the greater their percentage of the costs.
Though they may vary significantly, another major benefit of the NNN contract structure is how they develop a property’s reputation as an investment-grade building. NNN lease conditions will generally increase demand for the property down the line, especially since long-term, creditworthy tenants will pay similar fixed-rate rents whether the commercial property is worth $100 million or $600 million. This type of investment stability makes the property a highly attractive asset to long-term investors.
Key Provisions in a NNN Contract
The first clause you will find in a triple net lease is typically the rent clause. In this clause it will outline how much rent is due every month and discuss whether or not it is paid on the first of the month, or if you can set up automatic payments and pay it early. For example, one of the most typical clauses is that the rent amount is $2,000 per month and it is due on the 15th of each month. It also includes that there will be an additional $100 late fee if the rent is not paid by the 30th of each month. It even mentions that as a new tenant you have until the 15th of the next month to pay the first months rent, "as long as it will not interfere with the business."
The next clause outlines how the property taxes are paid. A typical clause states that "The Landlord shall be responsible for the payment of all real property taxes and assessments on the Property on a timely and appropriate basis. In the event of any discrepancy in the calculation of property tax the annual property tax bill shall be utilized in determining the correction of the discrepancy: provided that the Landlord shall obtain the written consent of Tenant prior to contesting any property tax assessment."
This clause is important because if your business expands ten years from now and you need to pay more in property taxes, you might have the option to fight the tax increase and hold off paying more, or the landowner has to pay the extra taxes.
The insurance clause states whether or not you have to purchase your own insurance for your business and what the limits are. This clause can be tricky because you want to make sure you have enough coverage to protect you from a potential lawsuit.
The maintenance clause is highly negotiable and isn’t always included in the lease, but it outlines who is responsible for repairs, especially if damages were beyond your control. During negotiations for a NNN contract, you could possibly negotiate for the landowner to pay for some of the repairs or even certain types of repairs. For example, the maintenance clause may outline "The Tenant shall be responsible for the maintenance and repair within the Leased Premises, including plumbing (except exterior doors, exterior walls, roof, foundation, and the exclusion of the cost of extraordinary repairs), walls, ceilings, electric, electrical panels, HVAC systems, heating and air conditioning, common areas of land and building. The Landlord shall be responsible for the maintenance of all other repairs within the Leased Premises including exterior doors, exterior walls, roof, and foundation."
NNN Contract and Other Types of Leases
There are other kinds of commercial real estate leases that are common practice in the industry. The most common of these are gross leases and modified gross leases.
With a gross lease, the landlord is responsible for paying all the operating expenses of a property. Rent is typically lower with a gross lease than a NNN lease (since the landlord is assuming all financial risk when they are also responsible for expenses). A gross lease can be beneficial to both landlord and tenant if implemented with care. While fewer services are expected from property managers, it is also easier for property owners to skirt responsibilities (and costly issues) if they neglect maintenance by failing to engage a professional service to handle it.
A modified gross lease is a hybrid between a gross lease and NNN. Some expenses, like taxes and utilities, are passed on to the tenant, while property taxes and commercial property insurance remain the responsibility of the landlord. A modified gross lease allows the landlord to enjoy some of the benefits of a NNN while taking on fewer responsibilities than with a full gross lease.
However, this arrangement comes with tradeoffs for both parties. The landlord must be much more involved in day-to-day operations of the property than when a professional third party (such as a property manager) is responsible for them. For the tenant, the primary advantage (apart from cost) is that only the bare minimum is expected of either party. A modified gross lease can be a good fit for parties seeking to reduce costs (for new or small businesses, perhaps) or desiring a hands-on approach to the management of the property.
All these lease types carry different levels of responsibilities for both parties. Choosing one over another means either adding or removing financial and managerial burdens. A NNN lease allows you to offload management concerns to an experienced third party, while allowing for greater financial security. But if you don’t need those services, a gross or modified gross lease may work best for you.
Possible Risks in an NNN Contract
While the process of purchasing a triple net property has its benefits, it also carries a number of risks that all parties to the NNN contract must be familiar with. The lease should contain language that guarantees certain obligations are met in a timely fashion to lessen the likelihood that the investor will be forced to adhere to unexpected maintenance and repair costs.
Some examples of costs that obligors may be held responsible for include unforeseen damages caused by natural disasters, structural repairs to the building, and issues relating to the building’s utilities (water, gas and electricity).
In many cases, the NNN contract will not differentiate between major and minor repairs to the property, so investors must remember that while they could be paying for a broken doorknob or cracked tile in a bathroom, it’s more likely that they will be required to also pay for anything related to the structure.
Any time soon-to-be vacant real estate is identified as an attractive investment, there’s also the risk that the market will change for the worse before a sale is finalized . In the event that the property loses tenants to a newly opened competitor, the investor could potentially be on the hook for paying for an empty building or even be required to pay for the construction and maintenance of an entire new building on the property.
And then there’s the possibility that the tenant defaults on their obligations, either by failing to pay rent, losing their ability to meet their responsibility as a company or going bankrupt. The Moral Hazard effect can be blamed—if the tenant has an incentive to neglect their obligations, they’ll be likely to cut back any way they can, including repairs. This means that the investor must hold a significant amount of cash on hand for the possibility of default.
Though the idea of acquiring an NNN lease is appealing, it doesn’t come without its set of challenges. Investors are therefore strongly encouraged to enter into NNN contracts with their eyes wide open, lest they find themselves on the hook to assume more than they bargained for.
Negotiate the Most Favorable NNN Contract
Negotiating an NNN contract can be a daunting task, as these leases often come with various responsibilities that can have significant financial implications. However, by arming yourself with knowledge of the common terms of an NNN contract and your opportunities to negotiate, you can set yourself up to save big time long term.
The first step in negotiating a favorable NNN contract is due diligence. Make sure you take the time to research the market and the typical lease terms for your area. This will help you identify any non-standard clauses where there might be room for negotiation. For instance, if you’re looking at a retail space in an area with a heavy amount of small businesses, it may be customary for the landlord to cover maintenance and repairs. Knowing this in advance would give you a point of leverage with which to negotiate a better deal.
The second step is to garner a full understanding of the tax implications of the contract. Certain contracts will require tenants to pay property taxes based on the assessment of the property, and a BIG component of your overall costs will be the tax that is paid. Depending upon the state you are in, there are a large variety of taxes, and some states even add additional income taxes that landlords will pass down to the end user of the expenses. By knowing what you will be liable for, you can make sure you get the best deal possible.
The third and final step is to leverage the current market against the landlord. If you find there is a surplus of what your particular business type needs, this can be important to use as leverage towards negotiating a deal that doesn’t include the expenses that they may try to pass down to you. For example, if you find that the market is leaning towards double-net leases, you would have a lot of leverage to get a much more favorable deal.
Also, keep in mind that you may be able to negotiate for expenses to be capped or capped with inflation. Even if a landlord is unwilling to cover a particular expense altogether, capping them will help protect you against rising costs in the future.
The Future of NNN Contracts
Looking ahead, the use of NNN contracts is poised to become even more relevant and widespread in the commercial property landscape. As technology continues to evolve, NNN contracts will likely benefit from advancements in property management systems. With the increased availability of detailed data and analytics, landlords and tenants utilizing NNN contracts will be better equipped to manage shared responsibilities more effectively and efficiently.
From a market standpoint, the forecast for NNN contracts is positive. According to a recent report by CBRE Research, NNN property transactions reached approximately $57 billion in volume in 2021, a trend that is expected to continue growing as investors seek more predictable cash flow and value retention during uncertain economic times . The demand for e-commerce stores, drive-thru restaurants, and healthcare facilities – all of which are typically leased under NNN agreements – will likely remain strong, which translates to stable demand for NNN properties in the future.
Furthermore, evolving tenant preferences and demographic shifts are expected to impact the commercial real estate market. For instance, the rise in younger generations seeking walkable environments is likely to increase the demand for neighborhood centers that feature NNN tenants. As businesses re-open in a post-pandemic world, retail properties with NNN leases will likely continue to benefit from a stable tenant base and consistent revenue.
In conclusion, the future of NNN contracts looks bright as technological advancements, market trends, and tenant preferences converge to create an environment that both landlords and tenants can benefit from. Understanding NNN contracts will remain important for all individuals involved in the commercial real estate industry.