Hidden Risks of NNN Lease Investments

A Triple Net NNN Lease Investments is a commercial property lease agreement in which the tenant agrees to pay rent, common area maintenance expenses, the landlord’s real estate taxes, and the building insurance. In real life, however,

NNN leases vary considerably and allocate responsibilities between landlord and tenant with considerable nuance. Because of legal nuance and its myriad variations, it is crucial that an investor pay close attention to the NNN lease that the tenant has signed and uncover and understand as many “hidden” risks as possible:

LOCATION: Even if a NNN property is located in populous, growing MSA an investor must ponder what might the next buyer pay, 10 years out for a McDonald’s in a “okay” zipcode, with three years left on term? 

EXPENSE CLAUSES:  Investors have to read the lease. Some NNN triple net property leases will require payment of a landlord’s administrative fee on top of reimbursable expenses being – taxes, insurance, operating expenses, utilities, etc.  If overhead (taxes, insurance, maintenance, etc.) is prorated amongst multiple tenants, then it is important to take a close look at the calculation. For e.g. is the proration based upon leasable space or occupied space?     

ABSENTEE MANAGEMENT: Highly passive and absentee investors may assume, mistakenly, that their NNN lease property tenant (value of a NNN) will maintain the property – as specified. That is one possibility: another is that a tenant can gouge the property with minimal maintenance, betting that the cost to litigate versus the cost to repair is in their favor!

BUILD TO SUIT: The more specialized a building is, the greater the amount the next tenant will expect the landlord to contribute in upfront tenant improvements.   Re-leasing can be challenging for an absentee investor who lives far away and/or does not have the capital necessary to remotely fill the property.

VACANCY, RELEASING, & NON RENEWAL:  What does an investor do with a vacant, former Walgreens or Taco Bell? Oftentimes, re-leasing is easier said than done. There’s a reason that a tenant is leaving, and it may have something to do with the location. Let us say that, on the flip side, the location is solid but the tenant fails, or decides not to renew. All these are risks that can be anticipated and must be considered within reason.

INSUFFICIENT GUARANTEE:  A tenant’s brand doesn’t specify to what extent it or a guarantor is obligated to pay the rent. Just because the tenant is Burger King, Verizon Wireless or Chic Fil A, doesn’t mean those companies are 100% behind the tenant. Even if the NNN property investment is company owned and not a franchise, the lessee could be a subsidiary, and the parent company may or may not be guaranteeing the rent payments.  

BANKRUPTCY: A tenant must have the financial strength to perform on rent payments. A track record in trade or business and future prospects of the tenant are both highly relevant.   But, a tenant can appear to be strong: if the tenant is a LLC or corporation with zero assets, it shields the tenant from honoring the lease. If a tenant goes bankrupt, the landlord is responsible for any damage done to the property as well as the tax burden. If a tenant neglects maintenance to cut costs, landlords can find themselves with an asset in deteriorated condition. 

INTEREST RATES:  The value of a NNN investment property lease is correlated to changes in interest rates. The relatively predictable income stream of NNN properties makes them similar in safety, to bonds. Just like bonds, when interest rates go down, the value of NNN lease property goes up.   

Avoid the hidden risks of NNN triple net property leases by calling on your trusted, expert advisors at the Triple Net Investment Group.