NNN (triple net investment) expenses shift almost all of the financial burden to the tenant, so these leases are very attractive for long-term commercial real estate investors. In this guide, we are going to dive deeper and see exactly what an investor can charge, how the expenses are calculated, and what can impact the NNN rate.
What Are NNN Expenses, and What Do They Include?
NNN expenses are extra fees incurred by the tenant or lessee in addition to a base rent fee. For commercial real estate, the base rent in a NNN lease is typically lower since the tenant is responsible for more of the ongoing costs of the leased space.
The fee is typically reported on a lease or building contract as a cost per square foot. You might often find a line item such as “$24/sq ft” on a net lease. This line item delineates the charges the tenant is responsible for.
NNN expenses typically include property taxes, building maintenance, and insurance. Essentially, the lessee is responsible for almost all of the costs of the building. A common term when referring to commercial triple net leases is Common Area Maintenance (CAM). Some of the CAM expenses include items such as:
- Roof structure
- Designated parking areas and garages
- Heating and cooling maintenance
- Exterior building repairs
- Utilities and water
- Landscaping upkeep
- Signs for the building
- Snow removal
- Security, CCTV, and access control
- HOA fees
These CAM expenses are not always guaranteed in a triple net lease. These are just a few of the items that can be included in an NNN fee. Even hiring a property manager or accountant is the responsibility of the tenant. Every lease is written differently, so make sure you read through yours thoroughly to know exactly what the landlord and tenant are supposed to pay.
What Expenses Are Not Included in the Fees?
Most of the time, triple net leases are negotiable between the landlord and potential tenant. The base rent often depends on how much the extra expenses are going to be. A landlord cannot wrap pre-improvements into the NNN expenses. Let’s say you make improvements on an office building to drum up interest from potential renters. You upgrade the bathrooms and carpet. Those expenses cannot be passed on to the new tenants after they move in.
Any expense incurred because of the landlord’s negligence cannot be passed on to the renters. If a landlord misses a payment, the cost cannot be passed on to the tenants. A landlord also cannot charge for business expenses that are not related to the building.
Can NNN Fees Change?
As said, every triple net lease agreement is different. In some cases, the charges can change up to a certain percentage throughout the lease agreement. In other cases, they may be fixed for the life of the contract.
Some costs are difficult to predict. For example, during the first year of the contract, snow removal might only be needed once. In the following years, snow removal might be needed many times. In some net lease agreements, the charges can fluctuate or be capped at 5%.
Landlords cannot simply raise the fees every year without cause. They must provide a detailed sheet with all of the possible costs upfront. Most of the fees are estimated based on the prior years.
What Can Impact the NNN Costs for a Commercial Property?
The charges will vary depending on the type of property, size, location, and how the property manager handles the property. So, what exactly impacts them?
NNN costs can be affected by weather and other environmental changes. If you have a season of heavy snowfall or intense heat, the building might need repairs. Property insurance and taxes have slight variations throughout the year. In these situations, the landlord will provide an estimate, and the tenant will pay off the fees as a monthly installment. At the end of the year, the estimated and actual fees are reconciled. If there are any overpayments, they will be credited back to the tenant’s rent. Any underpayments will be due to the landlord.
How Are NNN Fees Calculated for a Property?
NNN expenses are calculated in advance by adding the annual property insurance and taxes together. You must also examine the estimated maintenance costs for the year and add those in. Once you have an appropriate figure, divide it by the total building square footage.
If one tenant is renting the whole building, then your process is much easier. If you are renting a building to multiple tenants, then you must take into account the percentage of space each tenant is renting.
If that’s the case, add all of the totals for annual property taxes, building insurance, common area upkeep, and maintenance. Divide this number by 12 to get the monthly cost. If you have multiple renters, then simply take their monthly NNN cost and multiply by the square footage they are renting. You will arrive at your triple net lease amount.
Calculating Return on Investment for NNN Leases
Commercial real estate leases can offer a high return on investment (ROI) for investors, and charges in triple net leases are calculated for the investor to earn profit. Since the monthly rent paid on NNN leases goes to the investor, the return rates are generally high. We’ll look at ROIs based on the type of transaction you have used to invest.
If you’ve bought a NNN property outright with cash, then you should calculate the ROI using the capitalization rate. The cap rate is based on the level of equity and is calculated using an all-cash equation.
In this scenario, the cap rate is calculated based on the price of the property and the income it generates. Since there are very few landlord expenses, the rate is easy to calculate. Let’s look at a simple example. If you pay $2,000,000 for the property and your monthly net operating income is $150,000, then your cap rate is 7.5%.
$150,000 (Net Operating Income)/$2,000,000 (Purchase Price) = 7.5%
If you’ve taken out a loan to buy an NNN property, then your ROI calculation will look a little different. This calculation is used to determine the Cash-on-Cash Return (CoC). The reason we use this calculation is the interest on the loan is more important than the long-term cap rate. Your net income is determined by the amount of cash you receive minus the loan payment.
In this case, let’s say you are receiving $150,000 in rent, and your loan payment is $50,000. Your net operating income is $100,000. If you put $1,000,000 down on a $2,000,000 property, then your CoC return is 10%.
$150,000 (Cash Flow) – $50,000 (Loan Payment)/$1,000,000 (Cash Investment) = 10% Cash-on-Cash Return
Many properties qualify for a 1031 Exchange, which can greatly benefit the investor. A 1031 Exchange is a trade of one real estate investment property for another, which allows the investor to defer capital gains taxes. If a property qualifies as a “like-kind” property to one you currently own, which many NNN properties do, then you can exchange it without paying any sales tax.
One of the biggest expenses for any investor is their tax bill at the end of each year. You should be utilizing every tool you have to lower that bill. A 1031 Exchange provides a great way to defer taxes and take control of a new property. This investment property will continue to grow tax-deferred since you have not realized the capital gains on that investment. You can do this type of exchange as many times as you want as long as the property qualifies under the United States Tax Code.
One of the most important 1031 Exchange rules is that both properties must be for investment or business use. Also, an investor must identify another property within 45 days after they relinquish the first property as part of the deal. Another note – a real estate investor has 180 days to take receipt of the new property.
Overall, the “like-kind” exchange rule is fairly liberal. You can exchange many types of business properties for each other as long as you are in compliance. Many of the NNN properties on our website qualify for a 1031 Exchange. You can quickly search for these properties or receive a customized list to your email with new properties that fit your description.
As you can see, NNN properties offer commercial real estate investors an opportunity to make great returns while maintaining distance from the responsibility of fees associated with the property. This allows real estate investors to bring in cash flow without worrying about other property fees. If you are ready to start looking at NNN properties in your area, check out our listings to get started earning income with little overhead.