Populations across the US have increased dramatically in the last few years. In 2020, Utah, Idaho, and Texas all experienced population increases of over 15%. Rising populations bring more businesses, and more businesses mean more opportunities for investors.
If you’ve been looking for lower-risk investment opportunities in hot markets across the country, NNN investments may be your answer. These investments provide passive income on a commercial property without high financial and operational responsibility. In this post, we'll describe what an NNN investment is, its risks and rewards, and investor due diligence before buying NNN lease.
Table of Contents:
What Is NNN Investment
An NNN (or triple net lease) investment is a lease agreement where the property tenant agrees to pay all maintenance costs, property taxes, and building insurance associated with the property, along with rent and utilities.
Triple net leases are similar to single-net, double-net, and absolute-net in that the tenant is liable to pay for specified operating costs – or “nets” – that the property incurs.
- Single Net: The tenant is responsible for paying property taxes, rent, and utilities. The landlord pays for maintenance expenses and building insurance.
- Double Net: The tenant is responsible for paying property taxes, building insurance, rent, and utilities. The landlord pays for maintenance expenses.
- Triple Net: The tenant is responsible for paying property taxes, building insurance, maintenance expenses, rent, and utilities. The landlord may be responsible for any necessary structural, roofing, or parking lot expenses depending on the lease negotiated structure.
- Absolute Net: The tenant is responsible for paying property taxes, building insurance, maintenance expenses (including structural, roofing, and parking lot costs), rent, and utilities. The landlord is free of all financial obligations related to the property.
What Is NNN in Commercial Real Estate
NNN leases only apply to commercial properties – so this option isn’t available for residential real estate.
Many fast food chains and convenience stores with gas pumps as well as retail, medical, distribution, and industrial properties are under triple net lease agreements and are available for commercial real estate investors with a net worth of $1 million or more.
Because NNN investments place a large amount of financial responsibility on the tenant, rent is often lowered to account for property expenses. However, depending on how well you do your research before triple net lease investing, you could still expect anywhere from a 7% to 12% return on the property.
Keep in mind that some agreements include the projected operating costs in the monthly rent.
If this is the case, the landlord will have to track the monthly expenses – adding a layer of responsibility. If these operating costs were under the projected amount at the end of the year, the landlord will refund the necessary amount. If they were over the allocated amount, the tenant must pay the difference.
What Are NNN Expenses
Different real estate investments come with varying levels of responsibility and returns. Understanding your potential return on investment can help you determine whether a triple net lease is a good fit for you.
However, before you can find a projected ROI, estimate expenses for the given property. The table below gives benchmark expenses to consider for different NNN investments.
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Property Tax
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Building Insurance
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Basic Maintenance
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Structural Maintenance
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Single Net
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T
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L
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L
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L
|
|
Double Net
|
T
|
T
|
L
|
L
|
|
Triple Net
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T
|
T
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T
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L/T
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|
Absolute Net
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T
|
T
|
T
|
T
|
|
T = Tenant responsibility
L = Landlord responsibility
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A property’s capitalization rate (cap rate) is one way to see the current or potential ROI for any given property. Investors will also consider the cap rate during due diligence before buying NNN lease. To find your cap rate, use the formula below:
(Incoming rent - expenses) / property value
For example, say you find a property on the market for $2,500,000. Said property accrues a yearly rent of $150,000 and the landlord is only responsible for structural maintenance, your cap rate would look something like this:
(150,000 – 12,000 yearly expense) / 2,500,000 = 6%
Ideal capitalization rates are between 4% and 10%, ROI isn’t the only thing you should know about a property before jumping into the deep end though. Accounting for risks and understanding the potential rewards to offset those risks will help you better gauge your tolerance toward NNN investments.
Buying NNN Property: Risks and Rewards
As with any investment, NNN lease agreements come with risks and potential upsides. If you’re new to this type of investment, finding the right real estate broker who can walk you through how it works is crucial to your success.
Risks of NNN Investments
Much of the risk associated with NNN investments are related to unforeseen events. Having a backup plan and safety net with additional funds can help offset those risks. A few drawbacks to triple net lease investments include:
- Possibility of high repair costs: Although landlords are only responsible for structural repairs in NNN investments, those repairs can quickly add up – especially if tenants don’t immediately notify landlords of an issue.
- Tenant default: If you have a build to suit loan on the property and a single tenant declares bankruptcy or defaults on payments, there would be no other tenants to offset your financial losses. Investing in a multi-tenant property can help mitigate this risk.
- Limited upside potential: Triple net leases are typically fixed arrangements with a specified rent increase percentage each year. If the market grows at a rate quicker than your designated increase, you could lose out on higher gains from the open market.
Rewards of NNN Investments
The benefits of NNN investments present themselves in a variety of ways. Capital gains, a steady stream of income, and little risk are a few to name. Additional pros of triple net lease agreements include:
- Fewer financial responsibilities: NNN investments place most of the financial responsibility related to the property on the tenant.
- Predictability: Triple net leases often include 10+ year lease contracts, providing long-term tenant occupancy.
- Increased opportunity: Due to the limited amount of responsibility that comes with triple net leases, investors can purchase properties in hot markets, even if they don’t live nearby.
- Less overall responsibility: Depending on the terms of the agreement, the landlord may not have to deal with operating costs – leaving more time to focus on other investments.
20 Best States for NNN Investments in 2023
The best NNN investment opportunities are typically found in areas with increasing population and booming economic growth.
A state with low to no income tax can also save you a significant amount of money on your NNN investments. There are currently only nine states with zero income tax, highlighted in the 20 best states for NNN investments below.
