Whether you’re new to the world of commercial real estate (CRE) or have already tested the CRE investing waters, you may have surmised that commercial real estate can potentially bring an element of resilience to diversified portfolios.
But it’s vital to remember that not all properties or portfolios are created equal. One of the major differentiating factors between CRE portfolios is the type of lease structure tenants are bound by.
Below we’ll provide an overview of what a commercial real estate lease is and what different types exist. Note that leases are typically negotiated and there may be variations from what is described below, but the basic elements of each type of lease remain relatively similar.
What is a commercial real estate lease?
Just like a residential lease, a commercial lease is a legal and binding contract between a tenant and property owner, where the tenant is guaranteed use of the property in exchange for regular payments over a predetermined period of time. Keep in mind that there are various clauses included in a typical lease that may provide the tenant or landlord with various privileges, but the basic agreement of paying rent for use of the property is at the heart of every lease.
Gross Leases vs. Net Leases
The general responsibilities of the owner and tenant for the four most common types of commercial real estate leases include:
Gross leases – The tenant is only responsible for rent payments, while the property owner covers property taxes, insurance, maintenance costs and any other property related expenses that may arise.
Single-net leases – Under this lease type, the tenant is responsible for property taxes while the owner pays for insurance, maintenance costs and other expenses.
Double-net leases – The tenant is responsible for property taxes and insurance while the owner pays for any maintenance costs and other expenses.
Triple-net (NNN) leases – Tenants pay for property taxes, insurance, maintenance costs and any other expenses required at the property level.
It is important to note that the amount of rent the tenant pays most likely differs among these lease types based on how much responsibility the property owner has compared to the tenant. For example, gross leases typically have higher rents, because the owner factors in estimates of property taxes, insurance and maintenance costs into the rental price. Triple-net leases generally have lower rents when compared to gross leases because the owner doesn’t need to mark up the rent based on variable property costs.
More About Triple-Net Lease Properties
Portfolios composed of triple-net leases are constructed with the intent of minimizing volatility and uncertainty — in contrast to portfolios driven primarily by gross leases under which property expenses may vary widely month to month.
Property owners and investors generally like NNN leases because of the potentially steady and predictable income stream they create. This is because greater tenant responsibility may equal greater predictability. With lease terms that promise a steady income and minimal variable expenses, a NNN lease is viewed as less risky for the property owner. If the property suffers flood damage or the HVAC unit breaks down during a hotter-than-usual summer, the landlord is typically completely off the hook for these kinds of surprises as outlined in the lease. The landlord knows exactly how much income they will receive from a tenant each month without having to worry about variable property expenses popping up.
NNN leases also generally have longer lease terms, between 10-15 years with contractual rent increase built in. That’s why Modiv places a high value on long-term consistency and why we’ve built a portfolio with a strong foundation of NNN leases — it’s a smart strategy designed to help limit exposure to risk and volatility.
Even with a triple-net lease, there are still risks involved when investing in commercial real estate, a REIT or Modiv. You could experience illiquidity and complete loss of invested capital, and there are no guarantees dividends will be paid. Always conduct your own research and due diligence before you invest.
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The views and opinions expressed in this commentary reflect Modiv Inc.’s (together with its affiliates, “Modiv”) beliefs and observations in commercial real estate as of the date of publication from sources believed by Modiv to be reliable and are subject to change. Modiv undertakes no responsibility to advise you of any changes in the views expressed herein. No representations are made as to the accuracy of such observations and assumptions and there can be no assurances that actual events will not differ materially from those assumed. The forward-looking statements in this paper are based on Modiv’s current expectations, estimates, forecasts and projections, and are not guarantees of future performance. Actual results may differ materially from those expressed in these forward-looking statements, and you should not place undue reliance on any such statements. These materials are provided for informational purposes only, and under no circumstances may any information contained herein be construed as investment advice or as an offer to sell or a solicitation of an offer to buy an interest in any Modiv program or offering. Alternative investments, such as investments in real estate or REITs, can be highly illiquid, are speculative, and may not be suitable for all investors.