A net lease is like a household name to both a real estate investor and a realtor. But what about the common man who is just looking to own a property and is not conversant with all these real estate terms? This article is for you if you are in that category. You’ll learn everything about a net lease in terms of acquiring a property, and the relevance of REIT.
What Is a Net Lease?
The term net lease refers to a contractual agreement in which the lessee pays a portion or all of the property’s taxes, insurance fees, and maintenance costs in addition to the rent. In commercial real estate, net leases are often employed. In its purest form, a net lease requires the tenant to pay for all expenditures associated with a piece of property as if the tenant were the actual owner. A net lease is the inverse of a gross lease in that the tenant pays a flat rental rate while the landlord bears all other costs.
Types of Net Lease
Net leases are classified into four types. All of these are commonly employed in commercial real estate; however, the triple net lease is the most popular.
#1. Single Net Lease
A single net lease, commonly known as a N Lease, requires the tenant to pay both rent and property taxes. Because the taxes are paid through the landlord, who ensures that the tax payments are made on time, this is the one with the least level of risk for the tenant.
#2. Double Net Lease
The renter pays rent, property taxes, and insurance on the property in a double net lease, also known as a NN lease. The landlord is responsible for all property maintenance and repairs. Taxes and insurance are typically paid directly to the landlord, as in a single net lease agreement, ensuring that payments are sent to the relevant places on time.
#3. Triple Net Lease
The tenant pays rent, property taxes, insurance, and other expenditures when operating under a triple net lease, often known as a NNN. This lease gives landlords the least degree of liability for the property. In general, the basic rent will be significantly lower in this type of lease because the renter is responsible for all additional property expenses.
#4. Modified Net Lease
A modified net lease is a hybrid of a triple net lease and a gross lease. This sort of lease includes unique terms that are designed to meet the interests of both the landlord and the tenant.
When To Use a Net Lease
Net leases are most typically employed by real estate investors who wish to acquire properties and get the financial rewards of ownership without the hassle of property maintenance. As a result, landlords don’t mind taking a lesser rent payment because they don’t have to deal with property management.
Net leases are essentially used by property owners to shift the weight and obligation for taxes, insurance, upkeep, and repairs to the renter. In exchange, the renter pays a lower rent and usually benefits from a long-term lease.
What Does a Net Lease Include?
Net lease agreements can be negotiated to accommodate both the landlord and the tenant. It is critical to ensure that the agreement properly defines who is responsible for what expenses and details all negotiations.
Lease agreements will differ depending on the landlord, tenant, and type of property; nonetheless, most leases will include the following fundamental terms:
- Date of Agreement The day the agreement is signed
- The landlord and tenant’s names and contact information
- The physical address of the rented property
- Description of the property. A property description, including square footage
- Use of Property A explanation of how the tenant intends to use the property
- Term of the Lease When the lease will begin and finish, as well as renewal possibilities
- The rent is due. The amount and frequency with which the renter will pay rent, including that, constitutes late rent and the amount of any late fees.
- Rent goes up. Information regarding rent increases
- Deposit for security. Requirements for a security deposit
- The tenant is expected to maintain insurance coverage.
Because this contract is so crucial and must be drafted correctly, many landlords consult with a real estate lawyer to verify that all relevant clauses are included in the lease agreement.
Learn more about leasehold estates here.
What Is the Difference Between a Gross Lease and a Net Lease?
- Taxes on real estate
Landlords tend to charge more for rent when operating under a gross lease than when operating under a net lease since the landlord assumes all responsibilities for additional expenses.
Gross leases are desirable to tenants because they provide the convenience and stability of monthly rent payment. Furthermore, the tenant is not liable for any property maintenance or repairs.
Examples of Net Lease
Single-tenant net leases and multi-tenant net leases are two types of net leases. Both of these lease agreement examples offer distinct advantages to both the landlord and the renter.
Example of a Single-Tenant Net Lease
A single tenant net lease is frequently referred to as a triple net lease and is abbreviated as “STNL” or “NNN.” The entire property is leased to only one lessee in this lease arrangement, and the lessee is exclusively responsible for all property expenses. In this case, the landlord has little to no obligation for the property.
This is a common sort of lease in real estate investments where the owner does not actively maintain the property. This sort of lease has the advantage of being long-term, with durations of ten years or more.
Single-tenant net leases are most commonly used for the following categories of properties:
- Restaurants that serve fast food
- Leases of office space
- Stores of convenience
- Service stations
- Big-box retailers
- Retail establishments
Example of a Multi-Tenant Net Lease
Multi-tenant net leases are often double net lease agreements used when more than one tenant resides in the same building. Each renter will have their own net lease agreement with the landlord, under which the tenant will be responsible for paying rent, property taxes, and insurance.
Multi-tenant net leases are often seen in the following properties:
- Strip malls for retail
- Shopping centers
- Apartment buildings
- Medical facilities
- Buildings for offices
Landlords typically enjoy higher yields from multi-tenant properties; nevertheless, there is more labor involved because the landlord must manage many leases and is still usually liable for the property’s maintenance and repair expenditures.
Multi-tenant lease agreements are typically for shorter periods of time than single-tenant lease agreements, with multi-tenant lease agreements seldom lasting more than seven years.
Net Lease REITs
A net lease REIT, as the name implies, is a REIT that specializes in the acquisition and administration of net leased assets. There are several REITs to choose from for real estate investors that enjoy this structure. They are as follows:
- Realty Income (Ticker: O): Owns 6,750 net leased properties in the US, Puerto Rico, and the United Kingdom.
- W.P. Carey (WPC) has 1,250 net leased properties in 25 countries.
- National Retail Properties (Ticker: NNN): This company owns 3,150 properties across 48 states.
The particular structure of each company’s portfolio varies, although they often comprise single-tenant premises occupied by national corporations. The National Retail Properties portfolio, for example, includes 7-Eleven, Mister Car Wash, and Taco Bell. Because each REIT’s portfolio is unique, so is its performance.
Net Lease REIT Performance
REIT returns are made up of two parts: stock price increase and dividend income.
A range of factors influences stock price appreciation, including market sentiment, tenant occupancy, capitalization levels, leasing activity, portfolio performance, and tenant strength. Variations in these elements influence REIT price performance. To demonstrate this concept, the following chart depicts the ten-year return for each of the three REITs mentioned above:
National Retail Properties earned the biggest return from stock price appreciation alone of the three. This, however, is not the only return component. One of the primary advantages of investing in a REIT is that they are compelled to pay out a large portion of their earnings in dividends. When calculating returns, it is also critical to consider each company’s dividend yield.
Yield on Net Lease REIT
According to IRS regulations, REITs must pay out 90% of their taxable revenue in dividends. As a result, when compared to other corporations, they all offer high dividend yields. As of this writing, the dividend yields for each of the above REITs are:
- 3.93 percent rental income
- 5.42 percent for WP Carey
- 4.52 percent for national retail properties
Although National Retail Properties had the biggest stock price return, WP Carey has the highest dividend yield. As a result, the overall return for this REIT (price movement + dividends) could be larger. The idea is that Net Lease REIT performance should not be measured solely on stock price. Dividends are also a significant component.
The Benefits of Net Lease REITs
There are four advantages to participating in the publicly traded net lease REIT sector for commercial real estate investors:
- Low Minimums: The lowest amount required to invest in a net lease REIT is the amount required to purchase one share. This is frequently as little as $50 or $100.
- Liquidity: Shares in publicly-traded REITs can be bought and sold at any time, providing a level of liquidity that other types of commercial real estate investments do not provide.
- Investors benefit from a constant stream of passive income because REITs are compelled to pay out a significant percentage of their taxable profits as dividends.
- Diversification: As stated previously, each of the three REITs owns hundreds of properties. As a result, each share acquired provides investors with a high level of diversity.
Individual investors that emphasize income and have a short to medium-term time horizon choose REITs for these reasons (1-10 years).
Private Equity Investments vs. Net Lease REITs
A REIT is merely one sort of vehicle for investing in commercial real estate. Another common choice is to work with a private equity firm, such as ours. While the business model is identical – using investor funds to buy a diverse basket of commercial real estate properties – there are significant variations between the two. Among the most significant are:
Legally, private equity businesses are not compelled to pay out a large number of their earnings in dividends. As a result, they typically produce a lower cash flow stream, but…
Returns: Instead, a bigger portion of private equity returns are derived directly from property price appreciation. This can be more rewarding for investors in the long run.
Liquidity: “Private” equity investments are not publicly traded by definition. As a result, they lack the liquidity of publicly-traded REITs. They frequently mandate investment holding periods of 5-10 years, during which an investor cannot sell their ownership.
Deal Structure: Some private equity companies offer investments in a “fund,” which is akin to a REIT or ETF. Others, like us, provide investments in individual net lease transactions, allowing investors to conduct their own due diligence on the property and tenants.
When comparing net lease REITs and private equity investments, investors should investigate the characteristics of each opportunity and select the one that best meets their needs.
We’ve established that a net lease is a legal contract for leasing commercial real estate in which the tenant pays for both the rental space and any other expenses such as utilities, repairs, insurance, and so on. Net leases are appealing to landlords because they allow them to split the costs of the property with the renter. Tenants may benefit from net leases as well because rent payments are often cheaper due to the additional expenditures connected with the lease.
Frequently Asked Questions
Why is it called a net lease?
It is called a net lease because the property owner receives the rent “net” of the expenses that will be passed on to the renters.
What is the advantage of a net lease?
A net lease allows a tenant to better control costs by restricting the consumption of utilities. Furthermore, tenants are only required to pay the real cost of property taxes and maintenance. If no major construction is required or property tax rates fall, a firm can save money.