How Does a Triple Net (NNN) Commercial Lease Work?

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An NNN lease is very common in commercial real estate. I have used them on the commercial rentals that I own and on commercial spaces that I have leased. NNN stands for net, net, net. It means that the tenant pays most of the expenses. They pay the rent fees plus property taxes, property insurance, and CAM, or common area maintenance. The NNN fees are added onto the base rental fee, which is usually calculated as a dollar-per-square-foot number like $15. There is some confusion regarding what is covered on a NNN lease, but this is what I have seen as an investor/broker who owns and rents commercial spaces.

What expenses does the NNN lease include?

As we mentioned, NNN stands for net, net, net and is often called a triple net lease. The tenant pays their rent plus almost all of the expenses for the building. The tenant pays the property insurance, the property taxes, and the common area maintenance, which can include a number of things.

Common area maintenance (CAM)

When I first heard the term common area maintenance, I was thinking of a common area for many businesses, like a reception room or hallway. The CAM does include areas like that but also includes many more areas! Here are things that are often included in the CAM:

  • Roof
  • Parking Lot
  • HVAC
  • Exterior maintenance
  • Utilities for the building
  • Landscaping
  • Signage
  • Snow removal
  • Security
  • HOA fees

Often, even property management and accounting costs are the responsibility of the tenants to pay in a NNN lease.

What does the NNN lease not include?

While it seems like every expense is included in a NNN lease, there are some expenses that are the responsibility of the landlord or a particular tenant. I own a 68,000 square foot strip mall, and we have spent money on renovating vacant spaces for new tenants.

The money we spent fixing up an individual unit is not counted as CAM. If we paint the interior, add some walls, or remodel a bathroom, that is the landlord’s or that particular tenant’s responsibility. The work done on an individual tenant’s space is often referred to as TI, or tenant improvements. On our building, we agreed to pay for some of the repairs, and the tenant agreed to pay for other improvements.

When we painted the exterior of the building and made the entire property look nicer, that could be considered a NNN cost. Capital expenses may or may not be included in the CAM depending on the lease.

The landlord usually cannot charge the tenants for their own business expenses that are not directly related to the building, for any debt that the landlord takes on, for any late fees the landlord accrues for missing payments, or something that happened due to negligence from the landlord.

It is important to know that each lease is different and commercial leases can be very long and complicated. It is wise to have a professional review the lease for you to make sure it says what you think it says.

How are NNN lease rates figured?

The landlord determines what the NNN lease rates are, but they must be based on real expenses. The landlord cannot make up whatever they want and make the tenants pay it. In most leases, it is outlined how the NNN costs are figured, when they are figured, and how that information is delivered to the tenants.

On our lease, the landlord must figure the expenses and send a report to the tenants every year. The triple net costs are estimated at the beginning of the lease, but they can go up or down based on the actual expenses accrued. When we took over the building, the tenants were paying NNN costs of $1.50 a square foot. That rate was well below what the actual costs were for the building. The total cost is closer to $2.50 a square foot.

To figure that number, the landlord should calculate all the fixed expenses that are included in the NNN lease and maintenance costs for the building. They may also be able to charge some capital expenses based on the lease.

NNN lease versus an absolute lease

Commercial real estate can be confusing! There is a lot of opportunity in the business but also a lot to learn. One of the many confusing parts of commercial real estate is the different opinions of what certain terms mean.

For example, some people will say that none of the capital expenses are included in an NNN lease, only an absolute lease. It is hard for me to come to grips with this as most of the triple net leases I have seen include some form of capital expenses. I don’t know if these NNN leases are created incorrectly or the definition has become muddled over the years.

One of our tenants even has an NNN lease where they are not only responsible for all the costs on their unit, but they also pay them and arrange for all the repairs and maintenance! Your best bet is to read the lease and make sure you know what it says, not assume that an NNN lease is the same in every case.

Can NNN lease rates change?

One tricky part with NNN leases is that you cannot predict exactly what the expenses will be. Snow removal could be needed one time in one year or ten times the next year. The cost of management could increase, as could the cost of many things.

The triple net costs are not usually set every year but flexible. In my lease, the NNN can increase a maximum of 5% a year. So while our NNN costs are much higher than we are charging the tenants, we cannot increase those costs the entire amount. At the end of every year, we figure our expenses, send a report to the tenants, and can increase the NNN if those expenses are more than they are currently paying (but not more than 5% each year).

Each lease will have a different amount built in that the NNN costs can increase and some may not have any restrictions.

How much does each tenant pay?

Something else that must be considered is what each tenant pays for NNN costs on a multiple-tenant building. On my big building, we have six tenants who share the property. How do we know how much each tenant pays? The way the leases were structured when we bought it was each tenant paid their share based on the percent of square feet they occupied.

  • The grocery store occupies 82%, so they pay 82% of the NNN costs.
  • The restaurant pays 10% because they occupy 10% of the building.
  • And so on….

On top of the NNN costs and the base rent fees, the tenants pay their own utilities as well. Hopefully, the building has separate meters, or that can get tricky as well!

What would the total costs look like on an NNN lease?

Now that we know what is included on an NNN lease, or at least have an idea of what could be included on some, well…maybe not included on others…. anyway, what do the total costs look like and how do we figure them with rent?

The rent on a commercial building is often calculated using per-square-foot numbers. For example:

  • The landlord is asking $10 a square foot and there is 5,000 square feet. The total rent would be $50,000 a year (10 x 5,000) or $4,166,67 a month.

On top of this cost, the tenant would be paying utilities, which could be from $100 to $1,000 a month based on the use, climate, and type of building.

Now we have to add on the NNN cost which may range from $1 to $20 a square foot based on the use and costs. It is typical to see a $3 a square foot NNN cost in my area, which would add $15,000 a year or $1,250 a month to the costs.

Your base lease rent of $4,166.67 could easily turn into $6,000 a month actual cost.

Do NNN leases favor the landlord or tenant?

As you can see, there is no clear-cut NNN lease. They can all be different regarding what costs are or are not included. Some people may even say the common NNN lease is not even an NNN lease at all but an absolute lease.

Whether the lease favors the tenant or the landlord depends on many factors:

  • Did the lease come with tenant improvements?
  • Are the costs figured accurately?
  • Were both parties aware of how the costs are split?
  • Is the lease written clearly?
  • Was the tenant given a discount on market rent?
  • What condition is the property in?

NNN leases can be great for both parties or horrible for either party based on these factors and many more. Some of my properties use NNN leases and some use gross leases. They both have advantages and disadvantages for both parties.

What other types of commercial leases are there?

NNN leases are common on commercial real estate, but they are not the only type of lease used. There are many types of leases, and they have slightly different definitions based on who you talk t,o but here are the basics.

NN lease

This is very similar to the NNN lease, but only property insurance and property taxes are paid by the tenant. The maintenance is covered by the landlord, but the tenant still pays the utilities in most cases.

Net Lease

The tenant may pay a portion of the taxes based on their share of the building but not maintenance costs or insurance.

Absolute Lease

The tenant pays for everything and may even be responsible for taking care of everything as well. If the roof starts leaking, the tenant may have to call their roofer and get him over to fix it and pay him.

Modified gross lease

A modified gross lease is a mix of tenant and landlord paid expenses. The landlord typically pays the taxes and insurance, but the tenant still pays for their office expenses, such as janitorial. The utilities may be paid by the tenant or the landlord. There are many ways the expenses can be split, but with gross leases, the rent is usually higher than an NNN lease to make up for the extra expenses the landlord is paying.

Full-Service Lease or Gross Lease

The gross lease is when the landlord pays all the expenses including taxes, insurance, maintenance, utilities, and even janitorial service. The tenant just pays rent, which is usually much higher on a gross lease than an NNN lease.

Conclusion

There are many types of leases, and within those leases, different definitions for what they mean. We typically see NNN, absolute, and modified gross leases here. We rarely see NNN or gross leases, although they do exist. One thing is for sure, make sure you read the lease and know exactly what you are responsible for whether you are the landlord or the tenant!

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