Would you like to invest in a truly passive commercial real estate investment for the next 15 years where there are no management responsibilities, no landlord duties, no evictions, and no toilets to clean? It's like clipping coupons, or getting mailbox money on a monthly basis. Sound too good to be true? Well, surprisingly it's not. That is what we call a triple net lease investment. In this blog I will illustrate to you exactly how a triple net lease works in commercial real estate.
What is a Triple Net Lease?
When you go to a Starbucks, someone owns the Starbucks. Starbucks doesn't own the building, there is an individual who owns it.If you were the owner, Starbucks would pay you a lease payment every month. Let's say this amount is $20,000 a month. Under the triple net lease terms, Starbucks will pay for all of the expenses for the next 15 years. That's the best part about a triple net lease. Starbucks would be paying for your insurance, your taxes, all the building repairs, the parking lots, windows, roof, electrical, and more. They pay for everything.
So you receive a $20,000 a month lease payment from Starbucks. You then use this money to pay the mortgage if there is one, and everything left over is your cashflow. That is what we call a triple net lease, where Starbucks does not own the building, they're just the tenant, and they pay you a lease payment and cover all of the expenses. You just pay your mortgage and the rest if cashflow. You have no landlord responsibilities, no management duties, no evictions, and no toilets to clean. It's like getting mailbox money.
When you visit a large grocery chain, most likely, that grocery chain does not own the building, they're just a tenant that pays the owner of the building a triple net lease payment. The grocery chain pays all of the taxes, insurances, repairs, and other expenses. The same goes for most major restaurant chains, banks, and single buildings. They are not the owners of the buildings. There is a landlord who owns the building and the company leases from them.
Pros of Triple Net Lease
As I mentioned before, one of the great advantages of the triple net lease is the lease will last 15 to 20 years, and within that lease, every five years or so you're going to have rent increases. So, over these 15 to 20 years you're going to have rent increases that go up incrementally, and they are fixed within the lease, so that's a great and huge thing.
There will also be no landlord duties because your tenant pays for all the expenses. They pay for the taxes, insurance, repairs, roof, and everything in the building. There is nothing for the owner to do, other than collect your check, pay your mortgage, and experience cash flow. The best part is this type of cash flow is stable because of these three things, the long-term lease, no landlord duties, and the tenant pays for all of the utilities and expenses. Plus, there is potential for rent increases every five years.
Lastly, you have a low turnover, because they are in for such a long time. It's not like apartment buildings where the tenants last on average a year to 18 months. With a triple net lease, the tenants will stay a minimum of 15-20 years on most occasions.
The Ultimate Goal
For some of you, the triple net lease might be the ultimate goal. You may have invested for 20 years in your single family homes or apartment buildings, and worked your butt off to get where you are. Now you are pretty successful, but still involved in day-to-day doings of owning those rental properties. Now you think maybe you ought to back up a little, retire perhaps, and it will be ideal for you to go into triple net lease investments because of all of these advantages.
Cons of Triple Net Lease
But there are cons, there are minuses, there are disadvantages to all of these pros. Number one, there's a risk when the lease ends. If you owned a triple net lease property with four tenants; a hair salon, a shoe store, a large grocery chain store, and a pharmacy. Let's say that the grocery chain store lease ends after 15 years and they choose to relocate. Now you are only collecting three out of four rents, and your largest paying tenant is gone, leaving a big dark empty building. What do you do now? That's a risk.
Let's say that you have a triple net lease on a single-tenant bank, and the bank moves out. You are now 100% vacant, which can be a big problem. So the risk of doing a triple net lease investment, is what happens when the lease ends? A lot of planning involved can help to overcome and mitigate that risk, but it is still there.
High Capital Cost
Next is the high capital cost when the lease ends. Let's say you own that bank building, and the bank lease expires, so they move out. Now you have to get everything ready inside the bank building for a new bank or a totally different store. And guess what? Those costs are yours. You're paying hundreds of thousands of dollars to get that building ready for the next tenant. That's a con.
There is also limited upside if the market gets hot, because you're in a longterm lease that's fixed with increases. So if the market gets hot there's nothing you can do. You can't take advantage of it, you can't break the lease and increase the rents. When the market gets hot, you are held to the terms of your lease, so there's a limit to the upside.
All Triple Net Leases are Not Created Equally
Would you rather lease your single tenant building to Starbucks or to Joel's Coffee who only has one store? Of course, you want to lease to Starbucks because if they close down the store after five years, they will write you one check for the remaining 10 years. If Joe's Coffee go out of business that's it, you're left with an empty building. Even though both are triple net leases, a Starbucks will guarantee nearly all their rent that's remaining, whereas, a mom and pop shop cannot.
Who Should Do a Triple Net Lease?
In my opinion, it's the retiree looking for stable cash to live off of. I have a very good friend, who has owned her apartment buildings since we were kids, maybe in our twenties, inherited from her dad. She's an awesome person with a wonderful job, but last week she asked me, "Peter, what do I do when I turn 70, I don't want to continue to operate apartments, they're too much work?"
She is the ideal person for a triple net lease, because now she's ready to just kind of pack it in, do something that's extremely passive so she can enjoy the future grandkids. I explained the pros and cons to her and she understood them. In the next few years she is going to consider the triple net lease as a retiree option.
The next type of person that should do a triple net lease is someone that owns a five cap rate property. If this is you, then you're going to sell your five cap rate property and buy an 8% triple net lease property out of state. If you are in a high price area like I am in California, you're going to sell your high price, low cap property with all the equity.
This might not produce tons of cashflow because the price is so high, but you're going to maximize your equity by buying an 8% triple net lease out of state in the Midwest. You're going to buy a strip mall, or a bank building, or some triple net lease buildings out of state in the Midwest, or Southwest, some place, to maximize the equity here. So this is ideal for a person who has a high price property, lots of equity, who maximize their equity with cashflow while kicking back.
The third type of person is, when you're ready to park your money. If you're lucky enough to be a trust fund baby, or if you received a large inheritance and you're not sure where to put the money, but you need to put it someplace to start earning 4%, to 5%, to 6%, you would put it into a triple net lease investment for the next 15, 20 years. Or, sometimes international investors will take their money out of a very unstable environment, like in their foreign country, and they bring it to the most stable country, the United States, and invest it into a 15 to 20 year triple net lease property. That happens a whole lot and this country.