Net lease properties offer commercial real estate investors more passive ownership than traditional multi-tenant office or multi-family assets.
Net leases range from absolute net leases (triple net or NNN) where the tenant pays property taxes, insurance, sales tax on commercial leases, and maintenance; to single net leases where the tenant covers property taxes, but the landlord is responsible for insurance and property maintenance.
Net lease assets may be less passive than you think.
Despite the common misconception that net lease assets are completely passive, even within absolute net leases there are varying degrees of landlord responsibilities.
Landlords should request copies of general liability and property insurance certificates on an annual basis to compare coverage with the coverage required for double or triple net leases. Oftentimes, older leases may require higher levels of coverage than the tenant’s more recently negotiated leases. It is important to hold the tenant accountable to maintain the proper level of insurance coverage.
Landlords should also confirm property taxes paid by the tenant on an annual basis. A growing number of “absolute net lease” properties are also requiring landlords to perform annual reconciliations to be reimbursed fully for maintenance, property tax and insurance expenses.
This all means accountants and property managers must have a firm understanding of the lease and keep detailed records to prevent a loss of income during the reconciliation process.
You pay close attention to maintenance in a double net lease.
Double net leases place the responsibility for paying property taxes and insurance on the tenant. The landlord is responsible for a portion, or all, of the maintenance for the property.
In double net leases the landlord should build a frequent and recurring inspection and maintenance schedule. Annual roof inspections and routine maintenance may extend the life of a roof by 40-50%, allowing landlords to significantly reduce their capital costs over the term of the lease and ownership of the property.
The same applies to parking areas, building structure, HVAC, plumbing, and other property features. Routine maintenance and inspections allow costs associated with property improvements to be spread over a number of years, at easily forecastable amounts, and possibly deducted as expenses.
When landlords are forced to replace property improvements, the cost must be recorded as a capital cost, which cannot be deducted as an immediate expense, but must be depreciated over its useful life.
In short, active management is important.
All landlords of net lease properties should monitor their tenant’s performance at the property and corporate level to ensure cash flows will continue over the expected ownership period.
Net lease investors should also develop a firm understanding of the ownership requirements of each lease type prior to purchase of a net lease property. Failure to understand the nuances of a lease may result in unexpected monthly obligations and expenses for an investor.