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What You Need to Know Before Purchasing a Net Leased Property

As you begin to grow your real estate portfolio, managing multiple properties can become a bit demanding, especially without the support of a property management company. For this reason, investors looking for a more hands-off investment often pursue commercial properties with existing net leases and tenants in place. A net lease is a real estate agreement that requires tenants to pay a range of operating costs (such as property tax, insurance, and maintenance expenses) in addition to their monthly rent. While a net lease could technically be applied to any type of property, they are most commonly used for commercial properties such as retail spaces, warehouses, restaurants, and medical facilities (to name a few).

These types of leases are understandably appealing for landlords as they are typically long-term and offload most (if not all) of the financial burden to the tenant. Now I’m sure you are wondering why a tenant would feel compelled to sign a lease that seems to financially benefit the landlord. Well, in commercial real estate, tenants often need to significantly alter their units to suit their business and a net lease affords them the freedom to do so without much interference from their landlord. Some landlords even choose to lower the rent to incentivize tenants to take on the financial burden of maintaining their commercial property.

Admittedly, net leases aren’t for everyone but in the right circumstances they can be incredibly beneficial for both parties, which is why agreements often last anywhere from 3-10 years. With such long-term leases in place, it’s common for investors to inherent tenants (and their existing lease agreement) when purchasing a commercial property. For that reason, it’s important to understand the different types of net leases and get crystal clear on which type of agreement you’ll be inheriting when you sign on the dotted line.

Types of Net Leases

1) Single Net Lease: Tenants on a single net lease are responsible for paying their share of property taxes in addition to their rent.

2) Double Net Lease: Tenants on a double net lease are responsible for reimbursing their landlord for their share of property taxes and insurance in addition to their rent.

3) Triple Net Lease: Tenants on a triple net lease are responsible for paying their share of property taxes, insurance, and any common area maintenance (CAM) expenses, in addition to their rent. CAM expenses are limited to building facility repairs such as trash enclosures and parking lot lighting repairs.

4) Absolute Net Lease: Commonly mistaken for a triple net lease, an absolute net lease essentially places the responsibility of all ownership-related expenses on the tenant. So, in addition to paying rent, property taxes, insurance, and CAM expenses, tenants are responsible for any costs associated with the repair and maintenance of the structure of the building as well.

As you can imagine, a landlord’s financial obligations for a single and triple net leased property would vary considerably over the course of a 5 to 10-year lease, which is why it’s crucial to determine the type of lease you are inheriting. It’s also important not to allow the financial perks of a net leased property to distract you from the unique challenges of owning one.

The Challenges of Owning a Net Leased Property

1) Finding a Tenant with The Right Financials: As we’ve discussed, net leases are commonly used for commercial properties that house retail businesses, restaurants, and warehouses. While these types of properties can bring in some pretty hefty rents, they cost more and are usually set up for specific types of businesses, which limits your tenant pool. For instance, a company looking to rent a retail space won’t consider a space that’s set up as a restaurant since it would cost too much to reconfigure the space. Once you do manage to find a tenant for your specialty space, your work is far from over. You’ll also need to ensure that they have a solid track record, the financial backing to support the additional financial responsibilities of a net lease, and the desire to stay long-term.

2) Re-Leasing Vacant Spaces: Regardless of how well you screen new or inherited tenants, it’s inevitable that they’ll eventually vacate the property and leave you with the burden of finding a new tenant. This inevitability is why it’s important to pay attention to variations between what your tenants are paying and current market rental rates when purchasing a property.

While it may seem like a no-brainer to purchase a property with existing tenants that are paying rents above market value, the list price will reflect this, and you may end up paying more than the property is worth. Not only is this bad for resale value, but it also presents a problem once your tenant vacates the property. Why? Well, once they leave, their lease leaves with them and it’s unlikely you’ll find another tenant willing to overpay. So, to avoid holding a vacant property, you’ll have to lower the rent to the current market rate, which will affect your net operating income and projected returns (if you overpaid for the property). Unfortunately, this reduction in income has the potential to put you into default with your lender, which is something you want to avoid at all costs.

Taking over a net lease on a commercial property is certainly a unique opportunity that comes with its fair share of benefits and risks. Ultimately, it’s up to you to determine whether the perks are worth the potential downfalls — and that can be said of all real estate investments.


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