Triple Net Lease Pros and Cons for Tenants

Much of what is published about triple net leases is written for property investors. To them, a NNN lease is attractive because the tenant carries the costs and the income is predictable. That view is accurate, and it should make a tenant careful. Every benefit the owner enjoys from a net lease is a cost or a risk that has moved to someone else.

That does not make NNN a bad deal. Plenty of companies should sign one, and in some property types you may have little choice. What matters is knowing what you are accepting, and pricing it. This guide assumes you know the basic structure. If not, begin with our explainer on what a triple net lease is.

• A lower quoted rent. Base rent excludes taxes, insurance and maintenance, so the headline number is lower than a gross quote. That is a presentation difference until you have added the nets, but it can leave you room to judge the rent and the expenses separately.
• Visibility. You see what the building costs to run, category by category, and not only one blended number. Over time that history gives you something to question.
• You pay actual costs, not a landlord’s guess about the future. In a gross rent, the landlord prices in its view of future cost increases. In a net lease, if costs stay flat, you benefit directly.
• More control, in some cases. In a single-tenant building, a tenant that handles maintenance may choose vendors and set service levels. Control depends on what the lease allows, and it is rarely available in a multi-tenant building.

• Cost volatility. Your payment follows the building’s bills, and you carry increases from the first dollar. Epstein Becker Green notes that controllable costs typically exclude utilities, snow removal, insurance and real estate taxes, so those are often outside any cap.
• Budget surprises. Monthly payments are estimates. After year end, a reconciliation can produce a bill for the difference, and a low estimate in a proposal does not limit what you owe.
• Capital exposure. Depending on the lease, major items such as roof or heating and cooling replacements may be passed through, commonly by spreading the cost over a period of years. Epstein Becker Green advises that capital improvement costs be amortized over the improvement’s useful life, with the tenant’s obligation limited to its lease term.
• Unclear responsibility. Sources disagree on whether "triple net" includes roof and structure, because leases differ. A label that reads one way to you may read another way in the lease.
• Less landlord incentive to control costs. When costs pass straight through, the owner has less reason to shop vendors or defer spending. This is why audit rights matter.
• Administrative work. Someone in your company has to review estimates and reconciliation statements, and meet the deadlines for disputing them.

The largest risk is rarely the annual increase in CAM. It is a capital item you did not realize was yours, arriving late in a short term.

A net lease tends to suit a tenant that has room in its budget for variation, plans to stay long enough to benefit from any capital work it helps pay for, and has someone who will actually read the statements. A longer term in a well-maintained building, with a recent roof and modern equipment, carries different risk than a short term in an aging one.

It is harder to justify when your margins cannot absorb a surprise bill, when your term is short and the building has deferred maintenance, or when the landlord will not disclose expense history. Realized1031, which writes for net-lease investors, advises checking the age of the roof and the condition of the parking lot before choosing a lease type. That is equally sound advice from the tenant’s side.

Whichever way you lean, make the decision on total cost and risk over the term, not on the quoted rent.

Many of these points work best when raised in the letter of intent, while the landlord is still competing for your tenancy.

• ✓Does the lease say plainly that roof, structure and foundation repair and replacement stay with the landlord?
• ✓Are capital replacements excluded, or at least spread over the item’s useful life, with only the portion falling within our term charged to us?
• ✓Are expense exclusions listed in the lease, including leasing costs for other tenants and the landlord’s corporate overhead?
• ✓Is there a cap on annual increases in controllable expenses, and is it cumulative or non-cumulative?
• ✓Is any management or administrative fee stated clearly and limited?
• ✓Are insurance deductibles and claims addressed, so that we know what we could be billed after a loss?
• ✓Are variable costs the only costs grossed up, and do we pay no more than the landlord actually spends?
• ✓Do we have a clear right to review records, with a workable deadline to object?
• ✓Do we get notice before a large capital project is charged to tenants?
• ✓If the building is single tenant, what is the condition of the roof and equipment at delivery, and who pays if a system fails soon after?

Holland & Hart, writing on gross-ups, makes a related point worth keeping in mind for any of these: the tenant should not pay more than the landlord actually spends, and it should be able to review the calculation. Epstein Becker Green treats exclusions, a cap on controllable expenses and audit rights as points for tenants to negotiate. These are negotiated terms, not defaults, so assume they are absent until you see them in the draft.

1. Ask each landlord for the expense history and estimates in the same format.
2. Restate each option as a total annual cost, including items the nets leave out, such as electricity and in-suite cleaning.
3. List the capital and repair items that could be yours in each lease, and note the age of each system.
4. Model a reasonable increase in the nets, then test a worse year, to see what your budget can take.
5. Decide what you would pay to avoid that risk, then compare that with the rent difference to a gross option.
6. Have your attorney review the repair, operating expense and audit sections before you sign.

At Tenant Advisory Group we represent the tenant, so we approach a NNN proposal as both a price question and a risk question. We ask for the history, push on the capital language and put the options on one page so a client can see what the lower quoted rent actually buys.