By Mike Heayn Real Estate 101
DO YOU LIKE THE IDEA OF OWING A property, doing only a little management work on it and having a steady income month after month? If so, commercial properties with triple net leases may be for you. A triple net lease is where the tenant is responsible for paying the maintenance, property taxes and property insurance.
As an investor, the benefits of owning a commercial property with a triple net lease include a steady return with virtually no maintenance and management responsibility. If you are a busy person and do not want to deal with day-to-day real estate matters, a triple net lease gives you the benefit of worry free ownership. Nevertheless, like every business venture, there is no free lunch.
The downside to a commercial property under a triple net lease is that they usually offer lower returns. Most triple net leases last for several years, but only allow for a small rental increase annually or every few years. Thus, the return on investment over time can be smaller than purchasing another type of commercial property that does not have the rigid structure of triple net leases, such as an apartment building.
You might wonder why a business owner would not just purchase a commercial property for themselves and lease out some of the space to other tenants. The answer is simple and has to do with cash. A business owner may not want to place a large amount of debt against the business. In addition, a mortgage payment is usually a much larger sum than a rental payment. The more capital that goes to the mortgage payment the less that can go to running the business.
If you are purchasing a commercial property and the tenant is a well established business, the business will have a credit rating. A credit rating is given to a business from one of the rating firms. If you place a large retailer in one of your properties and that retailer has a strong credit rating, the property will yield a higher sales price than a business with a lower credit rating. However, even a strong tenant can run into problems. If the tenant’s credit rating drops, the value of the property could drop with it. It is important to pay attention to the tenant since you do not want your investment price dropping simply because of a poor credit rating on your tenant.
When renting to a commercial tenant, make sure that you do your due diligence. Ask a lot of questions and remember that the tenant will only be as healthy as the industry they are in. For example, you do not want to rent to a business that rents and sells only VHS tapes because VHS tapes are becoming obsolete. It would be better to rent to a business that is poised for growth.
Make sure that you negotiate a rental contract upfront, which may include future tenant improvements. Tenant improvements (or TIs) are property improvements an owner will pay for at a time over the lease period with specific price limitations. Normally, TIs are allowed after several years once the owner has made some type of return on the property.
No matter what type of investing you do, it is important to remember the basic real estate philosophy of doing your due diligence and asking a lot of questions. A good tenant could turn out to be a major headache even if they are on a triple net lease.
MIKE HEAYN is a Washington Mutual multi-family loan consultant. He (310) 428-1342 or
Originally published in the Santa Monica Daily Press print edition on March 14, 2007. Read the original PDF.