How Triple Net Works in an Industrial Lease

Holland & Hart explains that landlords commonly charge tenants the costs of operating, maintaining and insuring a building, and that in a triple net lease, all of the operating expenses are passed through to the tenant each year. The usual categories are property taxes, insurance premiums and maintenance costs, on top of base rent, though each lease draws its own lines.

In a single-tenant industrial building, you may pay many of these directly: your own landscaping and snow contracts, your own utility accounts, your own HVAC service. In a multi-tenant building, the landlord generally pays and bills you a share, with estimates during the year and a reconciliation later. Ask for your share in writing, along with how it is calculated.

Because there is no single official form, two leases labeled triple net can divide costs very differently. Never compare them from the label alone. Read the sections on repairs, operating expenses, compliance with laws, and alterations, then build a table of who pays for what.

Use a responsibility table when comparing proposals. Ask the landlord to answer each row for both maintenance and replacement, and then confirm the answers appear in the lease.

• Roof: patch repairs, the membrane, full replacement.
• Structure: foundation, slab, exterior walls, columns and roof framing.
• HVAC: routine service, major component failure, full unit replacement.
• Parking lot and truck court: sealing, striping, patching, full repaving.
• Loading equipment: dock doors, levelers, seals and overhead doors.
• Fire protection: inspections and system upgrades.
• Utilities: repairs to service lines inside and outside the building.
• Legal compliance: work required by law, including changes made because of your particular use.
• Management fee and administrative charges passed through with expenses.

These categories are where the phrase triple net stops helping. Law firm Lowndes lists a new roof and HVAC system replacement among capital items generally not treated as routine operating expenses, while noting that such costs are sometimes negotiated to be amortized over their useful life and partially passed through. A tenant should not assume those items are excluded, and should not assume they are included either.

Capital expenses are large costs that extend a property's life, as opposed to routine maintenance. The lease may handle them in several ways.

• The landlord bears the cost entirely.
• The landlord pays, then amortizes the cost over a period and charges tenants a yearly slice as an operating expense.
• The tenant pays directly, sometimes described as making the tenant responsible for maintenance, repair and replacement of a system.
• A cap limits what the tenant pays in a year or over the term.

Amortization makes the cost easier to bear, but the details decide its value. Here is a hypothetical, for illustration only, and not market data. Suppose a landlord spends $200,000 replacing a roof on a building you occupy alone, and the lease allows amortization over 20 years with no interest. The annual charge is $10,000. If three years remain on your lease, you pay $30,000 and the next occupant's lease carries the rest. Under a clause making you responsible for the full replacement, you would pay the entire $200,000 even though most of the roof's life would benefit the landlord after you leave.

Now look at what could change that outcome: the length of the amortization period, whether interest is added and at what rate, whether charges stop when the lease ends, and whether a renewal restarts anything. Each one is negotiable, and each should be stated rather than left to the landlord's accountant.

It usually helps to define which capital expenses qualify, state the amortization period, and discuss caps. Lowndes also suggests that parties may negotiate caps on controllable operating expenses and audit rights. Use the checklist below as a starting list for you and your attorney, and expect the answers to vary with your leverage and the building.

• ✓Does the lease define capital expenditure, repair, maintenance and replacement, instead of leaving them to argument?
• ✓Does the landlord keep the structure, roof framing and foundation at its own cost, with no pass-through?
• ✓Are capital items excluded from operating expenses, except a short list we agree to?
• ✓For allowed capital items, is the cost amortized over useful life, with only the portion falling within our term charged to us?
• ✓Is the interest factor, if any, stated and limited?
• ✓Is there an annual cap, on either controllable expenses or capital charges?
• ✓Are costs excluded when they result from defects existing at delivery, or from the landlord's or other tenants' actions?
• ✓Do we get notice and a chance to review a large project and its timing before it starts?
• ✓Do we have the right to audit expenses and reconciliations within a stated period?
• ✓If we pay directly for a large replacement near the end of the term, will the landlord reimburse the unamortized balance?

The last point has a basis in commercial lease commentary. Bean, Kinney & Korman describes a compromise, more often available to larger creditworthy tenants, in which the parties agree on a system's useful life and the landlord repays the unamortized cost of a system replaced in the last years of the term.

Strong language helps, but it helps most when you know what is coming. Roofs, paving and HVAC units do not fail at random times relative to your lease, and a building at the end of its roof life is a different deal from one with a new roof.

1. Ask for roof age, warranty, repair history and any planned capital projects.
2. Ask for several years of actual operating expense statements and property tax bills.
3. Hire qualified inspectors for the roof, HVAC and paving on any building you are serious about.
4. Check whether a recent or planned sale, reassessment or incentive expiration could change property taxes.
5. Build your own occupancy cost model for each building, including a realistic allowance for the items you may have to pay for.

Property taxes deserve their own line. In a net lease, a tax increase generally reaches you, and taxes vary sharply between jurisdictions. Your attorney and CPA should review how the lease treats reassessments, appeals and refunds.

A lower base rent with broad capital pass-throughs may cost more than a higher rent where the landlord retains the big items. Comparing proposals on base rent alone misses that. TAG represents tenants and buyers, and we lay competing proposals side by side on total occupancy cost and responsibility for capital items, so you can see what each one actually asks you to carry over the term.

Ask one direct question about every proposal: if this roof or HVAC unit fails in the final year of our term, what exactly will we pay?