Implications of the NNN lease to the tenant
Commercial real estate leases can sometimes be daunting to understand especially if it involves common terms like NNN. Getting the meaning of such terminologies is not easy as the exact definition can either be specific to an individual landlord or differ from property to property. Triple Net Leases, or for this matter NNN, is a unique term in the real estate sector. The three nets in NNN properties essentially means that the tenant will be responsible for maintenance, insurance, and real estate taxes for the leased commercial space.
For the landlord of that particular commercial real estate, this kind of lease appears as a perfect investment as there are no real overheads to cover. Specifically, the property owner will not be liable for insurance, no maintenance problems and also no need to hire a management company.
The components that are basic in the triple net lease (NNN Lease) are:
- Base rent
- Other specific charges to NNN’s like;
- Property insurance
- Property taxes
- Other Expenses and Charges (TBD)
- Common Area Maintenance (CAM’s)
At the time of negotiating for the base rent and lease charges, the NNN that is quoted is usually an estimate. Therefore, when computing the NNN’s charges, the Estimate is usually reconciled against the Actual figures.
Such a reconciliation usually occurs on an annual, semi-annual and quarterly basis depending on the landlord or property management company in charge.
How is the NNN lease structured?
The differences that emanate from the leases is usually due to the responsibilities and costs of the landlord and tenant.
- It is a lease structure that passes 100% of all the costs, risks, burden and responsibility to the tenant (s).
- According to its design, a triple Net lease seem to favor and protect the interests of the landlord against changes and other unexpected costs.
- It shifts the financial burden to the tenant thereby minimizing the landlord’s risks, responsibilities, and costs.
- With an NNN lease, especially due to property taxes, the property on sale will be more appealing to the new landlord.
NNN lease contain allot of expenses and risks
The huge risks involved in an NNN lease can be a nightmare for a tenant. Sometimes, if the unexpected changes occur on NNN charges, it might make the tenant loose business when the property becomes unaffordable.
Components of NNN charges that seem most dangerous
- Property taxes;
Any new owner of a property likes NNN lease structure since property taxes increase will just be passed over to the tenant. The new owner will further make adjustments on the NNN’s.
- The base year;
No matter where kind of lease, all leases are based on a base year. This the year in which all expenses that the landlord incurred to place a property in an operational condition at the time of signing the lease are accounted for.
For instance, if the base year is 2012, all maintenance charges will be computed from that baseline year. If it happens that in 2017 the property is sold, the base year for the charges and expenses will rise and be factored in the Estimate vs Actual computations.
Apart from that, there are also other changes like unexpected repairs, electricity changes, property tax legislation that are uncontrollable. This will change the operation and maintenance cost of the property.
Such a scenario will create a difference between the current expenses and base year expenses. Take an example of a property that in the base year had cost around $300 that now costs $350. The increase from the base year will be charged to the tenant and be in the Estimate vs Actual reconciliation.
- Common Area Maintenance;
These are communal like expenses that seem common to all tenants. They may include parking lots, walkways, shared driveways, electrical lighting and landscaping expenses. These expenses usually exhibit a high variance in the estimate and actual figures.
- Repairs and maintenance;
You normally expect that the building, repair and maintenance expenses of a commercial property to be covered by the landlord. However, when it comes to NNN leases, it is the obligation of the tenant to cater for all these expenses. This usually entails the space of the premises and any structural adjustment such as partitioning, roofing, and plumbing.
However, the tenant will proportionately share those expenses that don’t directly affect the commercial space. For instance, an upgrade of a building according to the new legislation or maybe a recent roof leak or pipe break. But, there are times when the landlord pays upfront for these expenses so that the work can be done expediently. Later on, all the expenses will be proportionately reconciled in the actual and estimate computations.
- Reserve accounts;
These are funds that the landlord collects from the tenant on a monthly basis to cater for significant repairs that might occur in the future. So, a tenant will pay money to the landlord controlled future maintenance fund. Afterward, the landlord will hold onto these funds and later notify the tenant when repairs are necessary.
Any rights that the tenant might have?
It is the right of a tenant to question the landlord about the changes in the actual and estimate figures before paying for anything. Landlords can sometimes commit an unintentional honest clerical error or an intentional robbery, which in all circumstances negatively affects the tenant.
What would a low NNN amount imply?
This scenario can mean a lot of things;
It could imply that for many years, the property has been in the hands of the landlord up to a point where it has become low in value. It might also imply that the running expenses for the property were lean. However, it might be a sign that the landlord wants to sell the property in the near future. Therefore, as a tenant, you should engage a tenant representative broker to investigate more on the low NNN lease.
What a high NNN amount imply?
It can give you a sense of peace of mind as it could be that the landlord recently acquired the commercial property. In the case where there is large property to hold onto, the property taxes payable on the NNN will be somehow stable.
When it comes to NNN lease kinds, don’t go alone but engage an experienced tenant rep broker to effectively negotiate and advocate for the lease terms. Most people tend to focus on the base rent in lease negotiations, but an experienced tenant rep broker will always negotiate for a lease that protects the interests of the tenant and minimizes on the expenses and risk exposures.