How to Calculate Triple Net Lease

How to Calculate Triple Net Lease

How to Calculate Triple Net Lease

 

There are several leasing structures available to those seeking to rent commercial space. However, a triple net lease offers unique benefits to both landlords and tenants. If you are considering this type of agreement here are some pros, cons, and formulas to help you calculate a triple net lease.

What is Triple Net Lease?

Calculations for renting commercial properties are much different than when renting residential ones. Oftentimes, spaces are divided, combined, or shared. Not only does it affect how much usable space you have access to, but also how much you pay each month. Therefore, most landlords determine rental fees with pricing by square footage.

While there are different leasing options for commercial space, many people utilize NNN leases or triple net leases. In this type of property lease agreement, the tenant/renter assumes responsibility for the additional costs to own and operate the property. These expenses include real estate taxes, insurance, and maintenance costs. Since the tenant is taking on more financial risk, they also receive lower rental rates.

How Do You Calculate Triple Net Lease?

When you calculate a triple net lease, you must determine both the base rental rate and the expected operational costs. These formulas and figures can become confusing, especially if there are multiple renters. Using a commercial lease calculator can be very helpful. But, you can also do the math for yourself using the basic format of base rent + additional assumed costs.

Determining Base Rent

To calculate the annual base rent, simply multiply the rate by the area. For example, let’s say the annual rate is $30 per foot for a space that is 2,500 square feet. So your formula would look like this:

$30/sq. ft. x 2,500 sq. ft. = $75,000 annual per year

Then, divide the total by 12 months. With these figures, that would give you a monthly rental rate of $6,250.

Calculating Additional Costs

In order to find the total for the additional costs, start by adding the annual fees for taxes, insurance, and expected maintenance expenses. Then, divide the sum by the total square footage of the space.

Although it seems simple enough, here is where calculations get tricky. The formula is much simpler if you rent the entire space to a single tenant. However, if there are several renters, your quote may be in Rentable Square Footage (RSF). In this equation, you must also account for shared financial responsibility to upkeep common areas such as lobbies, hallways, restrooms, and courtyards.

Another thing to consider when you calculate a triple net lease is the property value and associated taxes. While most owners use the previous year’s valuation on property taxes, large increases can severely impact the additional costs. It’s a good idea to review these figures and assess rental agreements on a regular basis since these expenses fluctuate from year to year.

What are the Pros and Cons of Triple Net Lease?

A triple net lease offers several advantages to both the landlord and tenant. However, many people avoid them because it does require more knowledge of commercial real estate laws and regulations. Here are a few important advantages and limitations to consider before you sign a triple net lease agreement.

Pros

Many people who rent out commercial real estate prefer a triple net lease agreement. It provides a secure investment vehicle with minimal risks. The owner continues to build equity due to capital appreciation of the property over time. Yet, the owner has more freedom since they do not play an active role in the property’s management. It also removes the financial obligations and risks of owning real estate since tenants assume the operational and management costs. Furthermore, it guarantees long-term occupancy since most state terms lasting 10-15 years. This gives the owner a stable source of income and reduces losses due to the property sitting vacant. Best of all, the leases are transferrable so you do not need to make investment decisions based on the duration of existing terms.

Although these leases may seem to favor landlords, it also provides many benefits for tenants as well. Since they assume more financial risk, it means they have lower rental fees. There is more room for negotiation as well since taxes and maintenance fees tend to fluctuate. With the landlord playing a less active role, tenants also enjoy more flexibility. A triple net lease grants tenants more freedom to customize the space to their specific needs. And, with longer leasing terms, it provides a stable location to operate their business.

Cons

While a triple net lease is attractive to both landlords and investors, there are some drawbacks to keep in mind. First, they are limited to commercial real estate. There are also net worth requirements for those wanting to invest in a property under a triple net lease. You must have a minimum net worth of $1 million, not including their primary residence and income. If you don’t meet this requirement, you can also enter a lease if you have an annual income of over $200,000. However, smaller investors must go through real estate investment trusts (REITs).

As the owner, you are also capping your earning potential. Most agreements specify fixed long-term rent for tenants since they assume the financial risks of the property. Therefore, there are limited opportunities to add value with updates or earn more from building if property values rise until the end of the lease.

Of course, you can’t overlook the financial risks the tenant assumes for the property. Although it may be a good deal when maintenance and operating costs are low, it can quickly turn against you. Increased operational costs, higher taxes, insurance deductibles, and damages can undermine your profit margin. On the other side of the coin, a tenant may not perform maintenance and repairs that meet the landlord’s standards. If you do not conduct regular checks on the building’s condition, the owner could be left with a huge list of repairs at the end of the term agreement.

The Fine Print of Triple Net Lease Agreements

The bottom line is that you should never enter into a contract unless you fully understand the terms you are agreeing to. While a triple net lease may be beneficial for both parties, do your research before you make a decision you regret. You can begin by finding information online, but it is best to seek legal counsel to review any rental or triple net lease agreements before you commit.

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