In searching for some blogging inspiration, I reached out to my facebook friends.  This is the question I received. ” Triple Net Lease: Give me the good, the bad and the ugly.”

Well, here goes!

Let me first explain what a triple net lease is.  A triple net lease (AKA net-net-net lease) agreement designates that the tenant (lessee) is solely responsible for all of the fees relating to the asset being rented, as well as rental fees.  The lessee has to pay for property taxes, insurance, and maintenance.

You will not typically see this type of lease in a residential setting, that is more typically structured in a Gross Lease.  A triple net lease has risk for both the tenant and landlord (lessor).  It is most common for larger chains (think Walgreens, McDonalds, Home Depot) to enter into a lease fro a very long time; typically 10 to 25 years.

The Good: For the tenant, the triple net lease can be great. A tenant has more freedom with the structure and can better customize a space for use WITHOUT the capital investment of a purchase. The tenant pays less for rent, as they have incurred other expenses.   This lease is quite customizable, and can have caps for tax increases, insurance increases, etc. For the landlord, triple net leases can be a solid source of income with little or no overhead costs.  The landlord will not need to play a very active part in the property.  The terms of a triple net lease can easily be negotiated, and longer term agreements (10 to 25 years) are common; equating to stable income for a long period of time.

The Bad: For the tenant, there are some unknown variables that might cause a problem.  Take for instance rising costs.  A triple net lease might have some sort of cap, but likely, a tenant would be forced to cover rising taxes and insurance rates.  Granted, this might not be much, but it could potentially cost a tenant a substantial amount of capital.  Imagine tax or insurance changes over the course of a DECADE; it could be substantial.  Then the question becomes: “What’s fair taxation for the lessee in a multi-tenant situation?”  It would be a good thing for a lessee to determine how this is handled and ensure that the lessee is comfortable with the setup.  *See table below from Landlord Tenant Law Firms.  There’s also no one saying that the status quo could never change.  The basis of the triple net lease is negotiation. Also, a tenant can not claim rent losses as business losses.

For a lessor, there might be problems with the building falling into disrepair.  A tenant strapped for cash (possibly due to rising insurance and tax rates) might let some of the maintenance slip.  Also, the tenant might fail to pay taxes altogether.  This could lead to disastrous consequences for a lessor.  Sometimes these problems are addressed in a reserve fund, so they may be a non-issue.  Speaking in tax terms, depreciation is calculated at 39 years, not 27.5 years.  That means there’s less of an income tax advantage.  It would be quite important for a lessor to know that lessee’s responsibilities are handled appropriately.

The Ugly:  It would be incredibly rare, but there could be issues with fraud.  Perhaps a lessee deliberately damages a building for the insurance claim. There is also the question of arson, for a lessor to lose the building that’s generating income, it could potentially be disastrous for both parties (especially if the lessee is skimping on insurance because of cost).

Table 1, below, shows what happens to each tenant’s tax obligation if it is figured on the basis of that tenant’s portion of the rentable space only. Table 2 shows what happens to each tenant’s taxable share when the landlord figures it according to the value of each tenant’s rented space. After computing the replacement cost of the property and each tenant’s share, the landlord applies that percentage to the tax bill, too.

Table 1: Allocating Taxes According to Rentable Space

Table 2: Allocating Taxes According to Replacement Value