A net lease in commercial properties is a contract where the tenant is responsible for paying all or a portion of the property’s taxes, charges, and maintenance costs.
Although most of the costs in a triple-net lease agreement are covered by the tenant, the landlord needs to stay on top of the accounting and accounting costs. In this blog post, we will go through the details of property accounting for NNN lease landlords.
Understanding Triple Net Leases
A triple net (NNN) lease requires the lessee (tenant) to pay three required expenditures related to the rented real estate: maintenance, insurance, and taxes. By comparison, a typical lease agreement compels landlords to cover these costs. The capitalization rate is used to compute the lease payment; it establishes the rate of return anticipated by a real estate investment. The credibility of the renter has a big impact on this rate.
Since renters spend a lot of money on the building’s operational expenses, the basic rent value under a NNN agreement is often slightly reduced. Additionally, the lessee has the option to set a maximum spending restriction, allowing the tenant to control swings in overhead. The landlord will cover a portion of the cost if upkeep, insurance, and tax costs surpass the cap.
Due to the elimination of tax responsibility, insurance, and property maintenance costs, NNN is a fantastic leasing alternative for landlords. Additionally, these types of agreements tend to attract a long-term lease of 10 to 15 years. To secure the best profits, a leasing agreement should also contain a provision for an annual increase in the lease amount.
Small investors who do not have the required net worth or income may also sign NNN leasing agreements. If you’re a small investor, you must make investments in Real Estate Investment Trusts (REITs) whose portfolios contain comparable properties to take part in the NNN lease.
What Does a Triple Net Lease Include?
A triple net lease has several provisions to know about. It’s important to fully comprehend the terms of any agreement you sign for services you provide. By using this guide, you can settle an agreement that satisfies your unique demands, rather than one that degenerates into restrictions.
A triple net lease often has the following legal clauses:
A triple net lease’s term clause details the lease’s tenure, including the start date, end date, and, in certain situations, any possible renewal choices. It would be in your best financial interest to consider the space’s future feasibility in light of the company’s planned expansion before signing.
By considering the rental term in the clause, it becomes easier to make profitability projections and account for potential vacancy (depending on the term of your investment, and the duration of the lease).
A rent clause might include anything outside only the monthly or quarterly payment. A rent clause could contain automatic rent rise provisions, for instance, which may have a substantial effect on the asset’s profitability during the lease.
Use of Property
A usage agreement outlines the permitted uses for the rented area. The conditions must be compatible with the tenant’s activities, which is crucial. If not, the landlord and lessee may have disagreements about the contract’s termination or bad faith.
Pro-Rata Operating Expenses
In a triple net lease, renters additionally pay the landlord or leaseholder for miscellaneous expenditures. The building’s insurance, property taxes, and upkeep of the common areas are all covered by the pro-rata running expenses. Usually, the landlord divides annual costs by the entire rental area of the building to determine the monthly payments.
How to Calculate Triple Net Lease (NNN)
When it comes to triple net lease accounting, there’s a lot for a landlord to be aware of. The following calculation can be used to determine the leasing amount in a triple net lease:
(Base Rent + Common Area Maintenance + Property Tax + Property Insurance)/12 = Lease Amount.
Total Leased Area x Rent Per Square Foot Equals Base Rent in this case.
The following are the processes for calculating the NNN lease amount:
- By dividing the entire leased space by the rent per square foot, you may first calculate the base rent. If the price per square foot is specified in monthly units, multiply it by twelve to obtain the price per square foot per year.
- Determine the annual cost of maintenance fees, property taxes, and insurance.
- Add base rent, maintenance fees, property tax, and coverage to that total.
- Lastly, divide the outcome by 12 to determine the monthly lease amount.
What is the Definition of Property Accounting?
Cash outflows and inflows are tracked in property accounting to determine overall profits or losses from renting out property. Overviewing rental revenue and costs enables landlords or lease business operators (or managers) to improve their strategic approach and boost earnings.
Real estate managers can discover net revenue from the many properties that a firm manages by using property accounting. To automate daily tasks like accounting, a lot of real estate rental businesses employ property management software. This becomes exponentially helpful if you’re managing more than one commercial investment. Property management software offers seamless accounting abilities to profit from commercial and residential rents, regardless of the size of your rental real estate portfolio.
Components of Property Accounting
By concentrating on the factors listed below, property managers or triple net lease owners can establish clear and effective property managerial accounting practices.
Assigned Bank Account
It is difficult to keep track of all corporate transactions when they are mixed with a personal account. Separate accounts should be kept and maintained for commercial and personal transactions. Not only will this keep your transactions simple and transparent, but it’ll also keep you on the right side of the law.
Furthermore, having separate property funds for income/expense and refundable security charges is recommended for landlords. It enables them to keep refundable deposits separate from working capital. Provided there are no damages, triple net lease landlords must return the security deposit after the lease period ends since they are short-term obligations.
Two different accounting techniques may be used by property managers to keep track of money coming in and going out with the triple net lease property.
Accrual accounting: Irrespective of whether the money has already reached the landlord’s bank or is still being processed, accountants record revenue and costs as they occur. For instance, the accountant will only include $1000 as monthly earnings in the accruing statement if a renter pays $4000 ahead for four months’ rent.
Cash basis accounting: Accounting on a cash basis involves recording transactions as soon as money is exchanged. For instance, if the rent is paid in full upfront, $4000, $4000 will be recorded as revenue.
In small enterprises, the cash-based accounting approach is common. Depending on how they wish to measure their revenue, building owners or accountants can use either technique.
To construct a financial report for the properties, property accountants might use information from the archives. A company’s performance may be shown in a number of financial statements, including:
- Income statement: Displays all earnings for the reported period.
- Cash flow statement: A cash flow statement shows the financial transactions that take place between various business units and a company’s banking information.
- Balance statement: The balance sheet keeps tabs on the assets and liabilities of a company.
Rental companies have the option of internally producing financial statements or using accounting software to record information and provide accurate reporting.
Accountants can arrange and maintain a spreadsheet notebook to log monthly transactions. This is appropriate for single-entry accounting, a favored accounting method in small enterprises.
In property accounting, a chart of accounts serves as a reference. When using accounting software, it might be in a separate tab, a text document, or a spreadsheet. Accountants can acquire insight into rental revenue and costs by using this chart of accounts. The books get more sophisticated while also becoming more detailed as a result.
IRS 1031 exchanges, which take their name from IRS Code Section 1031, are a crucial component of real estate management accounting generally, particularly in terms of taxation.
The use of a 1031 exchange to trade investment properties enables you to delay capital gains tax, however, it is what the tax deferral permits you to do that leads to the practical advantages of a 1031 exchange.
Changing the value of a property to one in a prospective market will increase your earnings and allow you to lay a claim in a growing neighborhood if you already own a property that’s not being put to good use.
You can also avoid the negative effects of market volatility. If you anticipate a significant change in the market, you can trade properties by moving from higher-risk to lower-risk options.
You must abide by the regulations to avoid losing your tax-deferral status and becoming subject to capital gains tax.
Regardless, 1031 exchanges can be tricky to navigate unless you’ve been through the process before, or have conducted reliable and diligent research. If you’re considering exchanging property you currently own for profitable NNN real estate, get in touch with the experts at NNN Deal Finder. We’ve helped match hundreds of clients with the perfect property to help them secure long-term, reliable income streams, and we’re ready to help you find your next NNN investment too.
Best Practices for NNN Lease Accounting
Here are a few best practices that landlords and property managers may use to grow their rental companies.
Waivers of Records
It makes it appropriate to substantially waive fees or prolong the payment deadlines in circumstances like a pandemic. To avoid significant payment dues, managers need to ensure that every waiver is monitored and recorded.
Software for Property Accounting
Software for property management accounting can be used for NNN lease accounting. To save time and effort, automate accounting-related tasks with special property management accounting software. It aids in the effective and efficient accounting for rental enterprises.
Have emergency money on hand. Despite having a perfect strategy, each property management company may encounter unforeseen costs. To address such expenses, set up a rainy-day fund and refrain from using the main business account.
Frequent Transactional Verification
Checking the books at the end of every month will help you avoid mistakes and catch typos, unsuccessful transactions, payment arrears, or overpayments while maintaining correct bookkeeping.
Examine Any Tax Deductions
Seek out chances to deduct expenses from your income and save money. Firms would have all of the transactions in one place with ideal property accounting, making it simpler to identify transactions that qualify for tax deductions.
New Lease Accounting Regulations’ Effects
Regardless of the type of commercial lease, changes are being made to how we account for leases. Any tenant entering into a lease is impacted by FASB’s new standard, ASC 842. The classification of leases is evolving. Lessees will now, in general, record the majority of their contracts on the accounting records.
Consider a few of the distinctions between ASC 840 & ASC 842. Leasing agreements fell into one of two categories under the prior standard, ASC 840: capital leases or operating leases. However, ASC 842 classifies a tenant lease as either a financial or an operational lease. Both forms of leases result in future lease payments being recorded as lease liabilities and a lease asset being recorded as a right-of-use (ROU) assessment on the balance sheet.
Ensure to consult with an accountant who is familiar with the new FASB guidelines to help with accounting for such changes. It is crucial to comprehend how the new standard impacts lessors and lessees participating in commercial leases.
When it comes to investing in a triple-net lease, understanding the accounting process is essential for a successful investment. The key to taking control of your accounting and minimizing mistakes is to stay up-to-date on changes in tax laws, rules and regulations that could affect your investments.
With the help of an experienced triple-net lease adviser like NNN Deal Finder, you can confidently manage your triple-net lease investments while successfully navigating any potential accounting issues that may arise. With their network of real estate professionals, investors, and advisors along with their in-depth knowledge of the triple-net leasing industry, they are the right team to guide you along your NNN investment journey.
So contact NNN Deal Finder to discover a profitable and reliable triple-net lease deal today!