Triple net lease properties have become an increasingly popular real estate investment in recent years. As an investor, you essentially purchase a commercial property that is leased to a tenant, but the tenant pays most or all property expenses like taxes, insurance, and maintenance. This transfers operating risks to the tenant and produces a stable, low-maintenance income stream for the investor. However, triple net leases also come with risks like tenant creditworthiness, illiquidity, and lease terms that must be properly evaluated. In this article, we will explore the fundamentals of triple net lease investing and how to maximize returns while minimizing risks.
Triple net leases transfer operating risks and costs to the tenant
The defining feature of a triple net lease property is that the tenant pays all or most of the operating expenses in addition to rent. This typically includes property taxes, building insurance, and maintenance costs. By transferring these variable costs to the tenant, the owner receives a smoother, more predictable income stream which in turn supports higher property valuations. Well-known national tenants with strong credit like drugstores, restaurants, and banks are common triple net lease occupants. Tenants agree to these leases because they lock in occupancy costs for budgeting.
Due diligence is critical to assess tenant credit risk in triple net lease properties
While triple net leases reduce landlord responsibilities, tenant credit risk is also higher. If the tenant experiences financial difficulties and is unable to make rent payments, the landlord is still responsible for property expenses. Conducting thorough due diligence on the financial health and creditworthiness of the tenant is therefore an extremely important step before acquiring a triple net asset. Reviewing metrics like the tenant’s debt leverage, revenue trends, and lease coverage ratios can help gauge their ability to fulfill rent obligations and survive an economic downturn.
Triple net leased properties offer stable cash flows but lower liquidity
The ongoing rent payments from long-term triple net leases are usually stable and predictable, making them appealing to investors who want low-maintenance cash flow. However, the specialized nature of these assets can also lead to lower liquidity. If the investor wants to exit, it may take more time to find an interested buyer familiar with assessing triple net lease properties compared to more conventional real estate. Selling on short notice often requires accepting a lower price.
Lease terms like renewal options and rent bumps can impact returns
Triple net lease terms directly affect the property’s cash flows and risk profile. Key provisions like the lease expiry, renewal options, and rent bumps or escalations should be reviewed. Shorter initial lease terms increase the risk of vacancy if the tenant leaves. But longer terms also lock in the rent, so inflation protection through periodic rental increases is ideal. Residual property value after the lease ends should also be considered in net lease investing.
Diversification through larger portfolios can reduce tenant concentration risks
Owning multiple triple net lease properties with different tenants across locations and industries can mitigate the risks from tenant default. REITs that focus on net lease property portfolios provide a more diversified approach for small investors. However, there are management fees and lower potential returns compared to direct ownership.
Triple net leased properties can generate stable income streams for real estate investors but also carry unique risks. Conducting due diligence, evaluating lease terms, ensuring diversification, and partnering with experienced managers are key ways to maximize upside and minimize surprises.