Net Lease Guide: How a Net Lease Works

A net lease is a type of real estate lease agreement in which a tenant is responsible for a range of property operating costs on top of their monthly rent. A net lease allows a landlord to collect property insurance, property tax, maintenance costs, and other building expenses from their tenant. These types of lease agreements are most common with single-tenant, long-term commercial leases for properties such as warehouses, medical facilities, or freestanding retail properties.

There are four types of net leases that each delineate the tenant’s responsibilities. The tenant still must pay a base rent or an amount of rent as determined in the net lease agreement for any of these agreements. The extra expenses vary depending on the type of leases.

1. 1. Single net lease: In a single net lease, the tenant pays for the building’s property taxes on top of their rent.
2. 2. Double net lease: In a double net lease, the tenant pays for the building’s property taxes and building insurance fees as well as rent.
3. 3. Triple net lease: A triple net lease is also known as a net-net-net lease (NNN lease). In this agreement, the tenant pays for the building’s property taxes, building insurance fees, and maintenance expenses as well as rent. This is the most common type of net lease agreement.
4. 4. Absolute net lease: Also known as an absolute triple net lease or a bonded lease, an absolute net lease puts the burden of all ownership and maintenance-related expenses on the tenant. These expenses include the building’s property taxes, building insurance fees, maintenance expenses, rent, and any other additional costs or property expenses specifically designated in the contract between the tenant and the property owner.

A net lease has many potential advantages for both landlord and tenant in many large, single-tenant properties and commercial properties.

1. 1. The landlord can be passive. A net lease allows a landlord to determine how much responsibility they have over their space during a tenant’s occupancy. They can take on less liability with property taxes and building insurance, as well as assume a more passive role in building maintenance than they would with a gross lease. This means that the landlord can still reap the benefits of property ownership without as much financial and credit risk.
2. 2. The tenant will pay less money in monthly rent. A landlord that leases their space with a net lease will typically offer a much lower monthly rent payment than a gross lease would. This is because the tenant assumes more responsibility and risk associated with the property. Meanwhile, the tenant can write off some of the extra fees (like property taxes) as business expenses.
3. 3. The lease is stable and long-term. The term of a net lease is typically longer than that of a gross lease. Some net leases can even be decades-long. For the landlord, a long-term tenant in a property is good for consistent cash flow from their rent payments. For the tenant, a long-term lease offers security and lower rent increases from year to year in comparison to market increases.

Both the landlord and the tenant assume some risk in a net lease. This type of lease is often only recommended for those with a strong credit profile as they can be a major financial burden with high risk. Here are some of the potential disadvantages of a net lease.

1. 1. Finding tenants can be difficult. Net lease properties are often specialty spaces, like warehouse or retail spaces, meaning that there are fewer viable tenants out there. If a tenant made custom renovations on a space, it may make that space less attractive to new tenants. This means that periods of vacancy are higher-risk in net lease spaces.
2. 2. The landlord loses out on market fluctuations. A typical net lease structure will have a rental rate that increases very slightly each year to account for inflation, but the rent won’t increase at the same rate as it would in the real estate rental market. While a consistent tenant means consistent cash flow, the landlord won’t be able to increase rent for the space to align with market prices, meaning that they can miss out on potential revenue.
3. 3. The tenant takes on increased risk and responsibility. The lessee in a net lease will be liable for many of the expenses for the building which can be somewhat unpredictable. For example, property taxes could increase, or the building may need a major repair for which the tenant would then have to pay.

Tenants leasing a property with a net lease are responsible for a range of expenses such as the property taxes for the space, the building’s insurance fees, and maintenance costs. In a gross lease agreement, which is sometimes referred to as a full-service lease, the tenant is typically only responsible for their monthly rental payment. Here are a few other ways in which these two types of leases differ.

• Types of property: Net leases are typically used by commercial renters, including large multinational chain corporations which can take on long-term, high-liability leases. Gross leases are typically used for residential properties.
• Degrees of tenant responsibility: Common net leases like triple-net leases (NNN) ascribe financial and operational responsibility for a space to the tenant. Most gross leases, especially for residential properties, place the responsibility of maintaining a space on the landlord.
• Monthly rental costs: Most gross leases have higher monthly rental rates than net leases, even in spite of the extra fees associated with net leases. This is because the landlord will typically elevate the price for a gross lease because they are taking on more liability and operational responsibility.

All investments, including real estate investments, come with inherent risks which may involve the depreciation of assets, financial losses, or legal ramifications. The information presented in this article is for educational, informational, and referential purposes only. Consult a licensed real estate or financial professional before making any legal or financial commitments.

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