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What are the current trends and challenges in the triple net lease market?

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A triple net lease (NNN) is a type of commercial real estate lease where the tenant pays for the property taxes, building insurance, and maintenance costs, in addition to the rent and utilities. This means that the landlord has minimal responsibilities and risks, but also lower returns. NNN leases are popular among investors who want a steady and predictable income stream from long-term tenants, such as retail chains, restaurants, or medical offices. However, the NNN lease market also faces some trends and challenges that affect both landlords and tenants. Here are some of them.

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1 Demand and supply

The demand for NNN leases has been high in recent years, especially for properties with essential or e-commerce-resistant tenants, such as pharmacies, grocery stores, or drive-thrus. These tenants have proven to be resilient during the pandemic and offer stable cash flow and low vacancy rates. However, the supply of NNN properties is limited, as many landlords are reluctant to sell their assets in a low-interest-rate environment. This creates a competitive and expensive market for buyers, who have to pay higher prices and accept lower yields.

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anca hartan

Business Development Consultant @ None Of Your Business | Master’s Business Analysis
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From a valuation perspective NNN leases do have double impact: 1. FMV with inside views on the types of recoverable costs and capitalized free rent periods ; 2. Misalignment of NNN leases with the IFRS principles related to other evaluation methodologies.

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2 Location and quality

The location and quality of the NNN property are crucial factors that affect its value and performance. Ideally, a NNN property should be located in a high-traffic and high-growth area, with good visibility and accessibility. It should also be well-maintained and updated, with no deferred maintenance or capital expenditures. However, not all NNN properties meet these criteria, and some may be in secondary or tertiary markets, or have older or obsolete buildings. These properties may have lower rents, higher vacancies, or shorter lease terms, which reduce their attractiveness and profitability.

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Carol K. Platt, RCE, CRB, CIPS, DIPC, e-Pro, AHWD

President - Platt Legacy Properties, P.A. Broker - Premier Sotheby's International Realty
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For mitigation of long term risk, location and quality of the real estate is a priority. Pay attention to demographics, shifts in local and regional land usage, road traffic counts and adequate ingress/egress and exposure!

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3 Tenant credit and diversification

Another challenge for the NNN lease market is the tenant credit and diversification. The tenant credit refers to the financial strength and stability of the tenant, which determines their ability to pay the rent and fulfill the lease obligations. The diversification refers to the variety and mix of tenants in a portfolio, which reduces the concentration and exposure to a single industry or tenant. Both of these factors are important for mitigating the risk of default, bankruptcy, or rent reduction. However, some NNN tenants may have lower credit ratings, or face disruption or competition from online or alternative businesses. This may affect their performance and viability, and consequently, the value and income of the NNN property.

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4 Lease terms and negotiations

The lease terms and negotiations are another aspect of the NNN lease market that pose some challenges for both landlords and tenants. The lease terms include the rent amount, escalation, duration, renewal, termination, and assignment options. The negotiations involve the bargaining power and expectations of both parties, as well as the market conditions and trends. Typically, NNN leases have long-term contracts, ranging from 10 to 25 years, with fixed or minimal rent increases. This provides security and stability for both landlords and tenants, but also limits their flexibility and adaptability to changing circumstances. Therefore, both parties need to carefully evaluate and negotiate the lease terms that best suit their interests and goals.

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James Parks

Real Estate, Lending and Business Transactions Attorney
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If you ask 10 different real estate professionals what they consider a NNN lease, you're likely to get 10 different answers - there are shades of NNN and different applications by property type. A free-standing, one-tenant building may truly be a situation where the tenant pays ALL expenses of maintenance, taxes and insurance. In a multi-tenant situation, it is more likely that the tenants will split their expenses on a pro-rata basis and that the landlord will likely have some limited maintenance responsibilities. The sooner you can involve your real estate attorney in the process (hopefully at the LOI stage), the better, as these issues can be fleshed out early and save you money and headache on the lease negotiation.

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5 Tax implications and financing

The tax implications and financing are another factor that affect the NNN lease market. The tax implications refer to the tax benefits or liabilities that arise from owning or leasing a NNN property. For example, landlords can enjoy depreciation deductions, capital gains treatment, or 1031 exchange opportunities, while tenants can deduct their rent and operating expenses. However, there are also some tax disadvantages, such as the passive activity loss rules, the unrelated business income tax, or the leasehold improvement depreciation. The financing refers to the availability and cost of capital for buying or leasing a NNN property. For example, buyers may face higher interest rates, lower loan-to-value ratios, or stricter underwriting standards, while tenants may have to provide personal guarantees, corporate guarantees, or letters of credit.

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Joe Archbold

Founder at Anthem Investing | Real Estate Investor I Syndication Rep
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An interesting way into a NNN lease through Sale Leaseback. One of our partners is getting strong tenants looking to free up capital by selling their real estate and leasing it back. Through Sale Leaseback they place low, fixed rate, longer term debt on the property acquired, and structures a long term, triple net lease with the tenant. ? Triple net leases are attractive as the tenant pays all the expenses and the rent is automatically increased each year providing a more predictable cash flow stream. ? Investors receive higher cash flow early on than typical CRE asset classes which can grow each year; and profits when property is sold

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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Mark Thiessen

Transaction Manager at RE/MAX Executives Winnipeg
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A challenge that needs to be identified in a triple net lease is the current condition of the building and its components. Items such as the roof or HVAC equipment as examples can be well into their estimated lifespan or economic life. Other building maintenance could also be a factor. Negotiating upfront who is your responsible for what or the amortization of the repayment of any replacements are prudent business decisions going into the transaction with ‘eyes wide open’. The value of your tenancy can be an enticing carrot when negotiating these terms because once the lease has been signed, it is the document that governs your future expenses.

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What are the current trends and challenges in the triple net lease market?

1

2

3

4

5

6

1 Demand and supply

2 Location and quality

3 Tenant credit and diversification

4 Lease terms and negotiations

5 Tax implications and financing

6 Here’s what else to consider

Commercial Real Estate

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What are the current trends and challenges in the triple net lease market?

1

2

3

4

5

6

1 Demand and supply

2 Location and quality

3 Tenant credit and diversification

4 Lease terms and negotiations

5 Tax implications and financing

6 Here’s what else to consider

Commercial Real Estate

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