One of the chief components of any successful real estate investment is the ability to accurately forecast and control both operating and carrying costs. Depending on the type of property an owner controls, operating costs can vary greatly due to the cyclical nature of demand for real estate. Operators faced with rising vacancies and lease-up costs can find their profit margins squeezed and therefore fail to meet their investment objectives. In contrast to the varying costs of owning and operating multi-tenant properties, investors can mitigate operating and carrying costs by investing in single-tenant, triple-net leased real estate.
An owner of a multi-tenant property is faced with a slew of varying costs, many of which can occur unexpectedly. Most landlords pass operating costs, such as real estate taxes and building maintenance, on to their tenants, proportionate with their share of space. As long as the tenant remains, the landlord is relieved of these expenses and will maintain expected revenue. However, if a tenant vacates the space, either due to closure or failure of their business and does not fulfill their lease obligation, the owner is then faced with paying these expenses. Depending on the current market for rental space, an owner may experience a long period before finding a new tenant. During this time, the owner is left not only without rental income, but also experiences added costs resulting in a cash outflow. In order to re-lease the space, owners are often obligated to pay for a build-out to suit a new client, in addition to paying brokerage fees. The largest cost building owners face, and the most unexpected, is structural failure or a need for extraordinary building maintenance. All of theses expenses lower profit and, in extreme circumstances, can lead to negative profitability. The reality of multi-tenant properties shows that owners cannot expect to maintain structured and consistent revenue.
An alternative to the fluctuating revenue experienced with multi-tenant properties is an investment in single-tenant triple-net leased buildings. Triple-net, also written NNN, leases obligate the tenant to pay, in addition to rent, all insurance premiums, real estate taxes, and building maintenance. Thus, the revenue to the owner is net, net, net of all operating costs. The obligation of the tenant to pay all building maintenance relieves the owner of all common building upkeep as well as any structural maintenance or repairs. NNN leases are usually long-term, 10 years or longer, sometimes with multiple options to renew. In addition, NNN leases are usually backed by a corporation associated with the tenant. Due to the structure of these leases, the main risk is the solvency of the guarantor; regardless of the particular location's profitability, the guarantor is obligated to fulfill the lease even if that particular location closes. This structure mitigates an owner's risk and the added costs of a vacancy. Since triple-net leased properties have much lower or no operating costs, cash flows from these investments are far more structured and consistent.
For investors looking to receive consistent and accurately forecasted revenue, single-tenant triple-net leased properties offer a significant advantage over multi-tenant and other types of real estate assets. Due to the low variance and structure of their cash flows, NNN properties are a crucial and comfortable component of a well-diversified real estate portfolio.
-Written by Sean Shanahan, Chief Financial Officer | Iridium Capital | sshanahan@IridiumCapLLC.com | visit our website
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