NNN Leases:
N = Property taxes and related.
N = Fire Insurance of the building
N = Utilities (limited to Water, Sewer, and Storm Sewer), General maintenance of the common areas, such as parking lot cleaning, landscaping, and in most cases, property management.
Under a "triple net leases" the above are paid by the lessee, (and revised annually), independently from the agreed upon leasing rate.
Under a gross lease, all of the above are paid by the lessor.
A very important difference...
What the Lessor remains responsible for are the cost to provide and maintain
1. The foundation.
2. The main outside walls, (or structural to the main building, NOT the lessee's improvements)
3. The roof and its maintenance.
The foundation, (provided one used a reputable sub-contractor), will rarely be a source of expenses.... if the foundation gives you trouble, 95 % of the time represents MAJOR trouble. The concrete walls, on average require re-painting every 10 years, the possible exception, (it does happen), when you have a signature national Lessee, it is very possible that the Lessor/owner will receive a nice letter from the Lessee flat out requesting new paint, say every 5 or 7 years :)
Other than that, maintenance of the same walls is nearly non-existent.
The roof is possibly the most common source of headaches...
Sometimes leaks are tough to locate, as the water could travel a fair distance from the point of entry (into the roof), and the actual point of leak.
Metal roofs have been a phenomenal solution, (as opposed to flat tar roofs, which can be real trouble spots).
Usually, metal roof are rarely replaced in its entirety, particularly now that they have come up with a covering component that is sprayed over the entire roof, (similar to a "porcelain" like material) that in essence, 'fills" any possible rupture, hole, etc. (mostly caused by either the fastening screws, or any opening caused to vents, or the like.
In addition, this material insulates the roof from heat (primarily).
Differences in heat/cold (day/night), in some areas can create a bit of a headache, by the expansion/contraction that results, to the point of creating movement in the metal seams.... originating leaks.
Finally, the "Utilities" portion of the last "N" usually refer to Water, Sewer, and Storm Sewer, but never to garbage (most times), electricity or telephone, (which is paid by the Lessee on an individual contract basis with the provider of the service).
When the income is derived from Gross leases, the property is not protected against the effects of inflation, since in most cases said leases do not include CPI escalators, (or similar).
In addition, a Lessee improvement can trigger a reassessment of property taxes, (which the owner is responsible for in the eyes of the county authorities).
Fire insurance is based on the building rating for fire hazards, such ratings are used by insurance companies (real complicated rating... done so on purpose, so no-one can question them, because no-one understands them, in spite of the claims by insurance companies that they say, they do) --<g>--
This means that the type of business, (or future expansion) of the Lessee, will determine how expensive the fire insurance premium for the building will be, including possible future increments, given the appropriate modifications by the lessee.
This is where the sprinkling system becomes extremely important since such system will reduce the cost of the premium.
The most important difference between a "NNN lease", and a "gross lease" originates from the fact that valuation of commercial real estate properties are based on applying a "capitalization rate" to the Net Operating Income (NOI), of the property.
As you can see, an NOI based on triple net leases not only is easier to determine, but it is protected from increases on the cost components of the defined NNN's
Any cost beyond the NNN in most cases are going to be minor ones.
On a gross lease, such costs are a little harder to see, when analyzing a property, (mostly dependant on how good the set of records are kept by the owner.... you should be surprised how "phantom-like characteristics" these costs all of a sudden take, when asking a property owner about these costs). Worse, the owner has no protection against increments of the same as explained above.
So.... in a practical example.... let's say that a property has an Net Operating Income of say... 250,000/yr. based on triple net leases.
Making the example simple, (we will accept that any other expense are minimal or non-existent, and that vacancy factors are soft, given a strong market).
Applying a capitalization rate of say 9.5 % (while interest rates do affect the final cap. rate, this is determined mostly by the leasing market strength).
this gives you a property value (based on income), of:
$250,000/.095 = $$2'631,578.95 ($2'632,000.00)
On a Gross lease, the same $ 250,000.00 is never "NET", it has to be "distilled", by first finding what the operating expenses are, then further reducing the figure by a risk factor, given the fact that there is no protection against inflation, zeal and hunger by the local taxing authorities, and evil insurance companies... <g>.
Bottom line.... NEVER INVEST IN A PROPERTY THAT HAS GROSS LEASES.
(Almost the equivalent of bulletin board "investments" --- well, not quite that bad) --just kidding--
This is another reason, (amongst many), why Apartment buildings are really not the best type of real estate...
Indeed, industrial warehouses are really hard to beat as an investment, they are not glamorous, and sometimes they are actually ugly... (not to me), but when it comes to performance... hard to beat... (don't forget the depreciation allowance which will always boost the return after tax. |
