Understanding NNN Agreements: What Tenants and Landlords Should Know

What Is an NNN Agreement?

NNN stands for Triple Net Lease. It is a type of commercial lease between tenants and landlords. It can be beneficial for the landlord as it provides more certainty, and is special to the tenant in that they get more control on how to pay their share of the lease. The two main components of the NNN lease are the net rent, the property taxes , the property insurance and the maintenance costs of the complex.
The net rent is simply the amount of money the tenant needs to pay to the landlord each month – the base rent. Property taxes are what the district or municipality requires in order to maintain the basic services provided to businesses. The property insurance is the amount of insurance the landlord must pay on the building and the land the business is leasing. The Maintenance costs are exactly what they sound like; the costs associated with maintaining the property.

How Are NNN Agreements Different From Other Property Agreements?

NNN Agreements: How they differ from other lease agreements: Gross and Modifed Gross
Unlike a gross lease, where the landlord pays the taxes, insurance and maintenance costs, a NNN tenant pays a portion of each of these expenses based on the square footage of the tenant’s space in the building. For instance, if there are 4 tenants in the building and each pays $100,000 per year in property taxes, the NNN tenant would pay a portion of that cost depending on the square foot of space the tenant occupies. In this example, if the NNN tenant occupies 5,000 square feet of the total 20,000 square feet, the tenant would pay 25% of 1/4 or 25% of $100,000 or $25,000 per year.
In a modified gross lease, the landlord pays some of these expenses (i.e., taxes or insurance) but the tenant assumes increases in the expenses above the amounts paid base year over the term of the lease. For example, if in year one the amount paid for insurance is $10,000 and the base year amount is $10,000, but in year two the cost of insurance rises to $12,000, the landlord is obligated to cover the amount of insurance expense above the base year amount, or in this case $2,000. This type of lease is usually coupled with a lease term that lasts a number of years, with adjustments every five years to market rate. A tenant may be willing to pay for a portion of these increases if the lease provides for no increases above market at renewal.
The amount of a NNN lease is based on current expenses, not prior year expenses or projected ones. For instance, if property taxes are $100,000 this year, the tenant pays a portion of the cost the next year based on the current property tax costs, not on a projected increase in taxes. However, if a NNN term applies the following folks are usually responsible for paying any increases and thus should negotiate the base calendar years for each expense; landlord, landlord’s lenders, tenants, tenants’ lenders or all of the above. In addition, consider increasing the responsibility for repairs and maintenance for the tenant. Landlords wishing to protect themselves from unforeseen repair and maintenance costs under a NNN lease should strongly consider including the clause requiring the tenant to cover all or a portion of these costs. The clause will limit the potential liability and ensure that the tenant is responsible for the items provided in the NNN agreement.
If the landlord is going to pay certain expenses, the provisions should clearly state which operating expense costs are removable from the lease. It is also important for landlords to understand how they can impose the allowable costs in the lease agreement.

Advantages and Disadvantages of NNN Agreements

Like many deals that are "too good to be true," there are always trade-offs, whether you’re an investor, lender, tenant, or landlord. The savvy investor with an experienced team of brokers and advisors may be able to avoid the pitfalls of overpaying and structure the deal to minimize risk. Investors who don’t have a handle on (1) what the property is worth, (2) what could impact value, and (3) having enough cash flow may face the potential of loss in a downturn.
Advantages to Tenants
Tenants enjoy distinct advantages under a NNN. For one, tenants can expect to pay less rent under a NNN lease than a gross lease. In good times, this is a big advantage, although NNN rents are more expensive than gross rents in down markets when landlords prefer long-term tenants with guaranteed rent. This is because NNN leases are much less expensive than buying the asset itself and tenants enjoy the freedom of being able to construct a buildout that meets their needs. Although many investors may not consider the refurbishment costs, it’s common for a lessor to help the tenant with the costs of build-out. In such cases, the tenant has the capital to spend on the build-out instead of paying the extra rent. Many lessors also offer rent abatement to tenants in-exchange for spending a certain amount on build-out. For example, abatement might be offered for every dollar spent on improvements in excess of $25 per square foot. This helps tenants in the near-term and gives the lessor a better, long-term tenant.
Disadvantages to Tenants
One of the biggest disadvantages to tenants is the need to pick up the check for any unexpected costs. A roof leak, structural failure, tenant build-out or even a parking lot replacement are all tenant expenses. Landlords rarely contribute. Tenants may be forced to pay for these repairs upfront if it’s an emergency situation. A handful of landlords who retain parties to cover the repair costs may simply add the expenses to the bill at the end of the month.
Advantages to Landlords
As mentioned briefly, landlords get the biggest bang for their buck from a NNN. NNN leases have reduced operating responsibilities and costs. Additionally, NNN leases allow the landlord to secure a long-term lease without the risk of vacancy. Long-term leases are attractive to investors and allow them to commit to the property for a longer period. For example, most NNNs entail 10-year terms but can span as long as 15 to 20 years. In addition, many NNN leases of this ilk offer price increases and/or rent bumps. This creates long-term income for the landlord that can be sold, assigned, or transferred as part of an asset purchase. Long-term leases also provide investors with a stable income stream to help fund the purchase of future assets.
Disadvantages to Landlords
The main disadvantage to landlords is the control they lose over the property. Once the tenant moves in, the landlord may have limited recourse over structural or otherwise significant tenants, such as national or regional chains. Landlords simply have less control than under longer-term or gross leases. Beyond that, as previously mentioned, landlords may bear some of the responsibility for the costs of tenant build-out and renovations. While many landlords negotiated to increase the cost of those improvements to the rent, the costs were borne largely by the landlord with a payoff period of 5 to10 years.

Common Terms and Clauses in NNN Agreements

Just as with any agreement, the typical NNN Agreement will include a variety of standard clauses, defining key obligations for the tenant and landlord. The landlord of the property will often stipulate that tenants agree to pay their pro-rata share of the building’s common area maintenance (known as CAM). This is meant to cover some of the costs of the maintenance of publicly accessible spaces in the property. It may also specifically exclude certain areas from CAM obligations. For example, the agreement may not require payment for maintenance on retail space used only for storage. In addition, there may be a cap on the amount of CAM for which a tenant will be responsible.
Property repair is another common clause, defining obligations for the upkeep of certain components of the building itself. For example, the tenant may be responsible for minor repairs, such as those to the interior of their shop. Major repairs, such as those to the foundation or roof, typically fall to the landlord. However, again, there are usually exclusions to this such as cases in which the damage was caused by specific problems such as mold or pests.

Tips for Negotiating an NNN Agreement

Nuances abound in every lease negotiation, including in triple net leases. Each side brings its own interests, and both sides need to be reasonable for a deal to be struck. Here are some factors that should be taken into consideration by both tenants and landlords when negotiating the NNN aspects of a lease:
Key factors in negotiating NNN terms
Negotiating an NNN lease takes time. A fair allocation of costs can be difficult to agree on between a landlord’s desire to recapture the property and a tenant’s comfort with some of those expenses. In an ideal world, the tenant signs a longer lease, so the allocation of costs allows for reasonable increases, though not too steep an increase over a five- or ten-year term.
It is critical to address items not covered under the lease or that would represent an unequal risk for the parties. Landlords should NEVER assume that the tenant will add flood and earthquake insurance to cover the property; tenants should NEVER assume they can obtain coverage that may not be available.
What can be negotiated
As with most leases, give-and-take is essential in negotiations. Although the landlord may want the NNN aspect of the lease to be "as low as possible , " it is important for both sides to consider how the structure of an NNN agreement makes it long-term appealing to a tenant. There are differing priorities amongst landlords in crafting NNN leases, so tenants should avoid assuming that if they ink a favorable deal with one landlord, it will be easier with another. Remember: Just because a deal is right for one landlord, it may be completely wrong for another.
Generally, a tenant should avoid anything unreasonably slanted in favor of the landlord. Many landlords feel that the NNN aspects allow them to make a profit on the property, which some tenants may feel causes a landlord to attempt to gain an unreasonable amount of control through the fine print of the lease.
Tips for negotiating fair terms
Landlords and tenants can negotiate to avoid issues down the road, and the goal of any NNN agreement is to balance the landlord’s need for security with the tenant’s need to keep ongoing costs that do not hinder their ability to succeed. The lease can provide that the tenant is responsible for first $50,000 of repairs, thereafter the landlord and tenant are responsible for paying their share of costs, up to certain limits, then they must split the rest. While not all landlords and tenants can get everything they want, negotiating throughout lease discussions can help to ensure a fair allocation of costs for both parties.

Frequently Asked Questions Regarding NNN Agreements

As with all legally binding documents, there is a number of important questions about NNN agreements that potential tenants of commercial real estate will no doubt want to address. Long-term tenants that are responsible for costs associated with their property may wonder how often and in what ways expenses can increase. Tenants may also ask if their landlord is obligated to use the funds for which they are responsible for purposes consistent with the lease agreement.
How much can my costs increase?
The tenant can expect annual cost increases that typically correspond to national CPI averages. The annual cost of occupancy is determined on December 31st of each year. Consumer price index (CPI) calculations are then analyzed by the landlord and tenant, who discuss areas of possible adjustment. Annual adjustments are made for charges that have increased based on the negotiation of the lease.
Are there any limitations on how the landlord uses my contributions?
There are typical limitations associated with any NNN agreement. Arizona law requires landlords to provide tenants with an accounting of any cash balance remaining in the tenant’s payment account. Unused funds from a tenant’s contributions cannot be used for any purpose other than the one for which they were provided. This requires the landlord to reserve the funds for specific expenses incurred by the tenant.
In the case of a dispute involving a tenant’s contribution, the landlord may not honor any sub-leases contained in the tenant lease. In other words, the landlord must first receive funds before allocating them to sub-tenants.
Am I joint and severally liable for the entire portion of the tenant’s lease agreement?
Tenant lease clauses can be negotiated to avoid joint and several liability. It is recommended that these types of restructuring be completed by an experienced professional in order to achieve the best possible outcome.

NNN Agreement Examples

The retail and fast-food industries are perhaps the largest groups of businesses using NNN agreements for their commercial properties. McDonald’s has arguably made NNN agreements popular, and many fast food franchises specify in their agreements that the franchisee must enter into a triple net lease. In addition to McDonald’s, other fast food companies that commonly use them include Taco Bell, Chili’s Grill & Bar, Starbucks, White Castle and IHOP.
Many drugstore chains utilize NNN leases as well. Walgreen’s, Rite Aid and CVS Caremark all use NNN agreements to provide their customers with retail locations throughout the U.S. Similar to these stores, both auto-parts stores and car rental companies require NNN agreements for their locations as well . Auto parts rental chain Rent-A-Part (also known as Rent-A-Quip) and car rental giant Hertz both commonly lease properties with triple net agreements.
Other fast-casual restaurants such as Quiznos, Five Guys Burgers & Fries, Firehouse Subs and Famous Dave’s BBQ are all known to use NNN agreements to market their retail locations. Many franchise-supported and independent grocery stores, including ShopRite, Giant-Landover, Key Food and Foodtown, also use NNN agreements for their locations. Because their stores are the anchor tenants in many shopping centers, landlords often require NNN agreements for the primary location in those centers.
Other common industries utilizing NNN agreements include childcare (notably KinderCare Learning Centers), convenience (such as Mobil Gas and Exxon gas stations), laundries and dry cleaning services, offices, shops, parking garages and trade schools.