There are several approaches to making money in real estate, but today I am going to focus on how to make money with real estate, using a triple net lease.
- Define what a triple net lease is and how triple net leases are typically used.
- Discuss the benefits of triple net leases and how they are a great tool to leverage more income from real estate businesses.
- How to get started with triple net leases.
- What to look out for with triple net leases.
- Final thoughts on using triple net leases.
A triple net lease (commonly referred to as NNN or “triple net”) is a rental agreement (typically commercial) in which the tenant is responsible for property taxes, insurance premiums, and structural maintenance and repairs to the property (in addition to rent).
Triple net leases are usually long term leases, going out into the future for 10 or more years, and usually have extension options. These long term leases also include provisions for increasing rent during the term, as well at the time of extensions to the original lease.
A triple net lease removes most of the risk of being a landlord in that the tenant is now responsible for everything – the landlord just receives the rent check, a great form of levered income.
Making money in real estate is about consistency.
By using a triple net lease with your commercial tenants, you are able to “smooth out” your income streams over the long term. The property now has a very long-term tenant (5, 10 or 20 years) that is responsible for all of the expenses associated with that property.
The property now has a consistent stream of income that you can count on far into the future. Additionally, you don’t have to worry about any expenses that may arise from repairs, increases in insurance, property taxes or other unknowns.
Making Money from Rent
As the landlord, your exposure to property expenses are removed from the equation and the rent check is pure profit (unless you have a mortgage on the property). For example, if you have a $1,000,000 property rented at a 7% CAP rate with a triple net lease, your income stream from the first year is $70,000.
Assuming a 10 year lease and 3% annual increases, your income stream looks like this:
Triple Net Lease Analysis - 10 Year Rental Income
|Year||Rent Increase||Net income|
|Total Net Income||$802,471.55|
At the end of 10 years, the property has thrown off $802,471.55 in rental income. This income can be sheltered via depreciation expenses (speak with your tax advisor) as well.
Making money from appreciation
Triple Net Lease Analysis - 10 Year Property Appreciation
|Year||Property Appreciation||Property Value|
|Total Property Appreciation||$248,862.97|
Assuming an increase in the property values of 2.5% per year, the property value at the end of the rental period is $1,248,863, an increase of almost a quarter of a million dollars.
Valuing a Commercial Real Estate property
Triple net commercial real estate is typically valued by its CAP rate (capitalization rate). The CAP rate can vary based on the quality of the property, quality of tenant and the duration of the triple net lease.
A high quality property will command a higher property purchase price and consequently have a lower CAP rate. A high quality investment grade commercial tenant will pay a lower amount in rent due to the unlikely event of bankruptcy and defaulting on the lease. A property with a shorter term triple net lease will sell for a lower price (and higher CAP rate) due to the fact that you will need to acquire a new tenant shortly (and pay the costs associated with the tenant change).
Ok, triple net leases sound like a “no-brainer” on how to make money with real estate. If you want to use commercial real estate to add new income streams, then a triple net lease sounds like the way to go. How can you get started?
Buy a commercial property and lease the property out.
This is a great approach if you know your market, have relationships with commercial real estate brokers and have ready access to capital. You need to find a desirable commercial property, purchase the property, find a tenant and perform the tenant improvements needed (if any). You will need to have considerable cash available for the property purchase and rehab (if needed).
Buy a property with a tenant already installed.
There is a huge market for triple net real estate investments with tenant already installed. Properties with tenants such as KFC, Starbucks and Walgreens as tenants are available at CAP rates of 4.35% to 6.25% (at the time of this article) from brokers that specialize in these types of properties.
The purchase of the property includes the tenant and the lease. Once you purchase the property, you can sit back and collect your rent for the next 20 years or so. Like with any “direct purchase” approach, you will need to have considerable capital to purchase these “tenanted” triple net lease properties.
Buy a REIT (real estate investment trust) focused on triple net real estate.
Purchasing shares in a REIT that is focused on triple net real estate is another way to participate in triple net commercial real estate. REITs (like Realty Income) trade like stocks and own thousands of triple net lease properties in their portfolio.
Invest at the property level with crowdfunded commercial real estate.
There are several online platforms that allow investors to group together to make “property level” commercial real estate purchases. These properties give the investor more control in selection, versus buying a basket of properties inside of a REIT portfolio.
Make sure the property has value, not just the lease.
Remember the first three rules of real estate:
Location – Location – Location
When purchasing a triple net lease property, it is easy to get caught up in the CAP rate, length of lease and tenant. One thing to never forget is the value of the underlying property.
A great property can always secure another great tenant, whereas a poor property with a great tenant will be difficult to re-lease.
Have solid lease guarantees.
Triple net leases are typically guaranteed by the company and in some cases personally guaranteed by the owner of the company (in the cases of smaller companies). Leases executed by large publicly traded companies (think Starbucks) are evaluated on the credit rating of the company.
As the landlord, you only make money when you get your rent payment. When asking yourself “how to make money with real estate”, one of the first rules is to make sure you protect those income streams (rent payments) as much as possible.
Diversify across properties.
In addition to diversifying across tenants, a commercial property owner needs to diversify across different properties in different geographic locations. Owning one $26,000,000 property is much riskier than owning twenty-six $1,000,000 properties.
One hurricane or fire will not wipe you out if you are diversified across multiple properties in multiple locations.
Commercial rentals (I equate commercial rentals with triple net leases) have the highest Lever Rank (35) of the direct real estate ownership levers (Residential Rentals have a Lever Rank of 25 and Vacation Rentals have a Lever Rank of 10) .
The higher Lever Rank for Triple Net Lease Commercial Rentals is due to the simplicity of the triple net rental model and the removal of all landlord responsibilities.
Since triple net leases sound like pure “mailbox money”, why don’t they have a higher Lever Rank like REITs or Affiliate Marketing?
The “triple-net” lease model is a great way to make money with real estate, but it does have some complexity and risk. To diversify properly into different triple net commercial properties with different tenants, you need at least $15,000,000 to minimize risk (fifteen, $1,000,000 properties). I would actually feel more comfortable with 20 properties, so that one property would not represent more than 5% of my income from the business model.
The high cost of entry (millions of dollars of capital), complexity, risk, liquidity and lack of diversity effectively reduces the Lever Rank to 35.
I currently have directly-owned triple net lease properties, directly-owned residential and commercial real estate, vacation rental real estate, crowdfunded triple net mortgage notes and triple net focused REITs, but my current focus is primarily on REITs (real estate investment trusts), my favorite real estate income lever.