Whether you already have some knowledge about NNN leases or lease escalations or it’s a new topic for you, we hope you’ll learn something from our 3-part series on lease escalations! This is Part 1. Stay tuned for the rest of the series!
Let’s define a NNN lease
First, what is an NNN (Triple-Net) lease? Here in the United States, landlords are responsible for paying maintenance fees, insurance, and taxes on their properties.
To cover these expenses, many landlords set up a “net lease” and charge their commercial tenants a fee (often referred to as “additional expenses” in the lease) on top of the base rent. Additional expenses could also be called Operating Expense Recovery or Common Area Maintenance Charges (CAM). Net leases help to lower the risk of investing in a commercial real estate property. The net lease structure also allows a landlord to adjust the base rent and the additional charges separately.
Triple-net isn’t the only type of net lease. A single-net lease only includes one of the three nets in the lease, usually property taxes. Double-net leases require the tenant to pay two of the three nets—usually, property taxes and insurance premiums. Finally, the most common type of lease is the triple-net lease. The triple-net lease is usually abbreviated to “NNN lease” in writing—encompasses all three nets in one.
What Additional Expenses Do Tenants Pay for in an NNN Lease?
Additional expenses may include a certain percentage of the following expenses:
- Common area maintenance (also called CAM or common use facilities)
- Utilities (gas, electric, water, telephone, etc.)
- Landscaping (mowing, snow removal, etc.)
- Property maintenance
- Property management
- Trash service
- Property taxes
- Insurance premiums and
By no means is this list comprehensive. But this list covers the largest categories seen in leases.
In any case, the lease should specify exactly what the tenant is helping to pay for. And, the tenant should know what percentage of the total costs they’ll be responsible for. The tenant’s percentage is usually based on the pro-rata share of the building. This means the tenant only pays for their portion of the building.
What Are NNN Lease Escalations?
On most commercial leases, the annual base rent is set to increase yearly. Generally, this is shown as a percentage. This is no surprise to anyone who has rented a space, whether residential or commercial. This annual increase is important. If rents never increased, it would be impossible for landlords to keep pace with inflation. And, most NNN leases are multi-year leases.
With a net lease, landlords can also adjust the expenses on a triple-net lease at a different rate or on a different schedule than the base rent. This ensures that commercial building owners can stay on top of property taxes, insurance premiums, maintenance, and operating costs— in addition to receiving the base rent each month.
For example, the “additional expenses” section of the lease may state that your monthly total will increase if property taxes increase during the lease term. Or, let’s say the cost of heating and cooling the building suddenly skyrockets—the landlord can share the burden of these costs among the tenants of the building.
Triple-net lease escalations are a way for landlords to control the risk of agreeing to a multi-year lease. Despite inflation, despite wear-and-tear, landlords can ensure that the building remains in good condition, year after year, while still turning a profit on their investment.
How NNN Expenses Change from Year to Year
In most cases, additional expenses will change at the beginning of each year. Often these expenses will increase, though it’s also possible for them to decrease. If you look through a commercial lease, you’ll see that additional expenses are estimated. This gives the landlord and tenants an idea of how much is owed for common area maintenance/operating expenses. The goal is for this estimate to be as accurate as possible.
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What Happens if NNN Expenses are Inaccurately Estimated?
As you can probably imagine, landlords must stay on top of NNN lease escalations. When landlords fail to keep up with increases on each tenant’s lease, it isn’t easy to recover the missed rent.
Finally, as part of a NNN lease, most leases require reconciliation that needs to be completed by a certain date. The details are generally outlined in the lease. And if the reconciliation is not completed on time, then landlords may have to forfeit any money that they would receive back. Or, just as importantly, a landlord may not be able to increase the additional rent for the following year. Additionally, if these expenses are inaccurately estimated, someone (either the landlord or the tenants) may find themselves having to come up with thousands of dollars that weren’t budgeted for.
Stay tuned for Part 2 of our series to learn more about why it’s important to have an organized system in place when dealing with NNN lease escalations.