Triple Net Leases Explained for Owner-Occupiers

A net lease places responsibility for building expenses on the tenant, in addition to the rent. The landlord receives rent that is close to pure income. In a triple net lease, written NNN, the tenant pays three categories of cost on top of base rent:

• Property taxes on the building and land.
• Insurance on the building.
• Maintenance and repair of the property.

The tenant also pays its own utilities and operating costs, as any tenant does. Almost every sale-leaseback uses a net lease, because the investor is buying an income stream and does not want to operate the building. It is also the natural arrangement for a company that has been running the building itself for years and knows it better than any landlord could.

There are degrees. In some triple net leases the landlord remains responsible for specific items, most often the roof and the structure. In an absolute net lease the tenant is responsible for essentially everything, and the landlord's ownership is fully hands-off. The label on the cover page does not tell you which you have. The repair, replacement, casualty and compliance clauses do.

Owners are often relieved to find how little the daily routine changes.

• You still pay the property tax bills, or reimburse the landlord for them.
• You still insure the building, now with the landlord named on the policy.
• You still hire the roofer, the HVAC contractor, the landscaper and the snow removal service.
• You still control who enters, how the space is laid out and how the operation runs.
• Your staff still call your own facilities person, not a property manager, when something breaks.

In budgeting terms, the building's operating costs carry over largely unchanged. The comparison to focus on is the new base rent against the mortgage payment that disappears, with the three nets treated as a constant.

The differences are less visible than the similarities and matter more over time.

• You pay rent, and it usually rises on a schedule. A mortgage eventually ends. Rent continues for as long as you occupy.
• You maintain to a contractual standard. As owner you could defer a repair or let a parking lot age. The lease will require you to keep the property in a stated condition, and the landlord can enforce it.
• You need consent. Structural alterations, additions, changes of use, subletting and assignment typically require landlord approval under rules in the lease.
• You insure to the landlord's specifications. Coverage types, limits and insurer quality are set by the lease and often by the landlord's lender.
• Capital spending benefits the landlord. A new roof you pay for in the later years of the lease belongs to the building owner when you leave.
• You have reporting duties. Many leases require the tenant to deliver financial statements periodically.
• You face an end date. When the term and renewal options are used up, your right to occupy ends unless a new deal is reached.
• Property taxes may change. A sale can prompt the assessor to revisit the assessed value, and under a triple net lease any increase is yours to pay.

Legal references on triple net leases make a related point: because the tenant covers maintenance and taxes, it bears unforeseen repair costs and tax increases unless a limit has been agreed. As owner you carried that risk too, but you also held the asset that the spending protected.

Routine maintenance is rarely contentious. The expensive question is who pays when something large has to be replaced: the roof, the parking lot, structural elements, or major mechanical systems.

Investors prefer an absolute net lease in which the tenant pays for all of it. A seller has reasonable arguments for a different allocation, particularly toward the end of the term. If you replace a roof with a long service life two years before your lease expires, you have paid for something the landlord will enjoy for decades.

Several approaches can be negotiated. The landlord can retain responsibility for roof and structure. The cost of a major replacement can be spread over its useful life, with the tenant paying only the portion that falls within the remaining term. Or the tenant can keep full responsibility in exchange for a better price, with eyes open. Each choice moves the price, because it changes how passive the investment is. What matters is that the trade is made deliberately.

Before you negotiate, get a current assessment of the roof, paving and major systems. You cannot price a replacement obligation without knowing how soon the replacements are coming.

The first draft will come from the buyer and will be written for the buyer. Go through it with your attorney and broker with these questions in hand.

• ✓Which repairs and replacements are ours, and are roof and structure included?
• ✓Is there any cap, sharing or amortization of major capital replacements near the end of the term?
• ✓What condition must we maintain, and who decides whether we are meeting it?
• ✓What insurance must we carry, and what happens to the lease and the rent after a fire or other casualty?
• ✓Who pays if a new law requires changes to the building?
• ✓Who is responsible for environmental conditions that existed before the sale?
• ✓Can we contest the property tax assessment ourselves, and do we receive any refund?
• ✓Which alterations can we make without consent?
• ✓What must we remove or restore when we leave?
• ✓What financial reporting do we owe the landlord?

TAG negotiates net leases on behalf of tenants as its core business, so in a sale-leaseback we review these clauses the way a tenant's advisor would, not the way a seller's agent focused only on closing the sale would.

Not inherently. A net lease gives you something valuable: operating control of the building with little landlord involvement. Companies that have run their own facility for years generally prefer that to waiting on a property manager. The base rent in a net lease also reflects the fact that the landlord is not paying the expenses.

The risk lies in open-ended obligations, such as an unlimited duty to replace building components or to cure conditions you did not cause. Those are the provisions to narrow. A triple net lease with clear limits on capital replacements, sensible alteration rights and fair surrender terms is a workable long-term arrangement for a former owner.