NNN Leases

Triple net leases are nearly as dangerous as Franchise Agreements, and require intense due diligence. NNN leases are mainly written for retail spaces - office space is still mostly "gross". There are several ways severe nastiness can happen to a tenant/lessee. Prop 13 in CA effectively froze property taxes a couple decades ago, but the building gets revalued for tax purposes when it is sold. I was a Subway franchisee in a building that had been owned by the same family trust since 1939, and when they sold the building a couple of years ago, my pro-rata portion of property taxes went from $18/month to $500+/month - OUCH! Also, and this was alluded to in an earlier post, many leases have NO restrictions on how to characterize an expense that can be passed on to the lessee. So even though the Landlord is putting on a new roof for $150K that they will then amortize over 20 years or so, they will charge the existing tenants the entire amount of the capital improvement in the year incurred. So even if you have 3 months to go on your lease, and then you are moving - so sorry, you get to pay the freight for the next few tenants. Ugly but true. What is really annoying though is when the landlord charges the tenant all other expenses of managing the building, including the overblown salary of the lazy and incompetent property manager and the rude accounting clerk. A NNN lease gives the landlord NO incentive to carefully and prudently manage expenses, because all the costs get passed on to the tenants. Is there any defense? Pay a good commercial real estate attorney to represent you (tenant/lessee) to the landlord before you sign that lease. Don't trust "your" broker who only gets paid big bucks by the landlord when you sign that lease. Get a fixed number for the CAM charges in the lease, and negotiate an annual ceiling to the escalations. And get a clause that amortizes any capital expense that the landlord makes. There are many more nuances to NNN leases, but this is a start. These are the battles the franchisee must fight before, during, and after the challenges of dealing with a usually predatory franchisor. Tell me again why people elect to do this!?*

Can anyone tell me when triple net leases came into vogue? - Fuwa 

My guess is that the triple net lease rage is quite recent. Google Trends lab shows a huge jump on Internet searches for "Triple Net lease" since January, '08.  There are isolated articles on these leases from trade journals of the late 90s though.

Double and triple net leases have been in vogue for some time now.  I think you'll find that NNN Leases rise in popularity will closely parallel the overall interest in Section 1031.

Triple Net properties tend to be "Equity Investments", rather than "Cash Flow Investments".  The investor will usually finance a significant portion of the purchase price and pay the resulting mortgage with the lessee's monthly owed rent.  The investment payoff does not result from the monthly cash flow, but rather from the equity acquired using the lessee's rent money. 

Few real estate investments are simpler than investing in a triple-net-leased property.  It has even been compared to buying a bond.

Believe & Succeed,
Dale
FranSynergy, Inc.
Synergizing Franchising!
www.fransynergy.com

I assume you are referring to NNN leases in strip malls and mixed-use type leases since this forum is about franchises - besides the McDonald's of the world, franchisees are all pretty much in shared small retail. NNN is much more common in strip mall type situations versus AAA office, etc.

I started seeing NNN dominating the major markets around 15 years ago. In places like Nevada and Arizona, they were created as a vehicle to hedge additional exposure for the developer/landlord and in response to more investors looking to flip the property in a hot market where they build equity for 5 or so years off of the rent paid by tenants - versus just "living" off the cash flows like the old days.

I think the rise of NNN might have also been the other variables like common-area insurance, utilities and maintenance costs becoming more unpredictable in the late 90's. If you can get your tenants to take on all the risk of utilities, etc...that's a good deal, eh?

It went from NN to NNN to completely offload all the remaining variables to the tenants. The banks were driving the demand for NNN arrangements more than anyone else - again to offload risk.

Trouble is - what works well in a strong economy does not always function in a not so hot paradigm...it is starting to backfire. The combination of out-of-control business property tax increases, utility costs, etc. are placing pressure on the landlords...some landlords are even waiving annual escalators or lowering base rents since finding replacement tenants is not as easy as it was even 12 months ago in many markets and they certainly cannot flip that property as easily.

In my area, the vacancies and space for rent signs are quite noticeable. This is going to be interesting because the former hyper-growth municipalities are counting on business and land taxes to fill the gap caused by the other revenues decreasing. Economics 101. We'll see.

I just want to thank Dan and Dale for their contributions to this thread.   And encourage others with insight to post. 

FuwaFuwaUsagi

Has anyone seen  a study that examines the rise in tripe net leases and business failure?

My instincts tell me that once corrected for the general economy there should be a correlation.    

FuwaFuwaUsagi