Triple net properties are fairly misunderstood by many real estate investors, even though they have their fair share of benefits. In a conventional gross mortgage, the tenant pays rent to the landlord who then pays bills such as the real estate taxes, building insurance and maintenance. In a triple net property, the occupant pays these bills as part of the lease agreement in addition to the rent. Triple net property tenants do not pay utilities; that is sometimes part of a percentage or “gross” lease. Triple net properties may be industrial, office space or retail but are rarely residential. In this article, we’re going to touch on some of the pros and cons of triple net properties.
The Pros of Triple Net Properties
One of the advantages of triple net investment properties for the landlord is eliminating these expenses. Another is that by shifting these “net” expenses to the tenants, some of the management hassles are reduced for the landlord.
Since rent is typically lower for triple net leased real estate, the property is less likely to be vacant. The common practice of signing very long leases for triple net properties also gives investors peace of mind, since the property should yield a steady, predictable stream of income.
If your investment property contains one or more major triple net lease tenants, banks may give you a lower interest rate when buying the property or refinancing it because it is seen as a lower risk deal than if you have constant turnover.
The long term, predictably paying tenants who take out triple net leases are valuable to other real estate investors, making such properties easier to sell to other investors quickly whether you need the cash for personal expenses or want to upgrade to a 1031-exchange.
Owners of triple net investment properties keep all of the same tax advantages as other landlords but with less book keeping.
The Cons of Triple Net Real Properties
One of the risks of triple net investment properties is that you are assuming the tenant will maintain the property, which they may not. If the tenant delays repairing a roof or takes minimal steps to mitigate flood damage, you risk major, costly structural repairs later. Since you’ve deferred maintenance to the tenants, they may not tell you about these issues because they don’t want to pay the associated costs under the triple N lease.
If the tenant has to pay the deductible and chooses a fly by night operator for repair work, you may not know there was damage from a bathroom flooding or roof leak until they move out and the building inspection finds the hidden damage. If the tenant lets the insurance policy lapse and something serious occurs, now you have little recourse but to pay for the repair costs out of pocket. The shifting of the cost of maintenance and insurance to the tenant and the multiple reasons they may neglect it to your detriment are the biggest downside to triple net investment properties, if things go wrong.
If you assume the tenants are paying the property taxes and they fail to do so, you could lose your property to a tax auction. Fortunately, monitoring that taxes have been paid on time is much easier than inspecting a rental property on a regular basis.
Observations about Triple Net Real Estate
Tenants may be attracted by the ability to negotiate lower property insurance rates for their own, financial benefit, whether taking extra steps to reduce the odds of burglary or raising the deductible. However, only the landlord can contest property tax evaluations. A landlord who leaves the property taxes entirely to the tenant may miss out on the opportunity to challenge valuation appraisals, much to his or her detriment when the bill comes due without a tenant legally obligated to pay it. And if you’ve been paying the ten percent per year increases for several years, you cannot go back and say, “This is too high.” If the property taxes are unrestrained, then you’re faced with potentially higher than market rate rents because you’re the only one who didn’t challenge the valuation increases and have to raise rents to a rate to cover these costs.
If your lease agreement doesn’t have the right limit on capital expenditures, you could end up taking on many little projects that you intended to have paid for by the tenant. If the capital expenditure cap is too high, the tenant doesn’t have a reason to report issues to you and has good reason to seek the cheapest solution for major repairs.
Triple investment leases have the potential to reduce marketing and turnover costs for landlords while simultaneously taking part of the management burden away from landlords. The tax advantages are the same while bookkeeping is significantly simplified, since the landlord doesn’t have to track as many expenses. The risks arise when tenants don’t keep up the property or pay for insurance, putting the landlord’s property at risk.