Net lease real estate investment trusts have been some of the top-performing property sectors this year, despite facing a challenging macroeconomic environment. Considered “bond-like” and sensitive to interest rates, they have achieved double-digit earnings growth in spite of rent growth falling behind inflation, according to Forbes Magazine.
The growth can be mainly attributed to robust external acquisitions, which have offset the impact of slower property-level growth. Let’s dive deeper into the world of net leases and net lease investments.
Defining Net Leases
Net leases refer to a commercial real estate lease in which the tenant pays the base rent and a portion, or all, of the associated property expenses. These expenses may include property taxes, utilities, repairs, insurance, and maintenance costs. Net leases are commonly used for single-tenant commercial properties such as industrial warehouses, restaurants, and retail stores.
Typical examples are drugstores like Rite Aid, CVS, and Walgreens. As tenants, these drugstores pay rent to the landlord and are responsible for all other costs. This takes significant pressure off of the landlord, making it a superb investment opportunity. To learn more about Walgreens for sale, visit the Pharma Property Group’s website.
In an ideal scenario of a net lease, tenants carry all of the associated property expenses, as if they were the real owners. Conversely, with a gross lease, the tenant only pays a fixed rent; while the landlord is expected to handle all other costs, from property tax to maintenance.
For tenants, a net lease can involve taking on additional risk. The rent may be lower than other types of leases, however, the associated property costs could increase over time, resulting in higher overall expenses. Advisedly, tenants should carefully consider the terms of the net lease to ensure that the potential rent savings will offset any potential increases in other costs.
Overall, net leases can be a valuable tool for landlords and tenants. Landlords can focus on other aspects of their business, while tenants save on rent. However, it is essential that both parties thoroughly analyze the terms of the agreement, to make sure that the arrangement is mutually beneficial.
What Types of Net Leases Are There?
You’ll find three primary types of net leases: single, double, and triple net leases, each with its own terms, conditions, advantages, and drawbacks.
Single Net Lease: The tenant pays rent and associated property taxes. The landlord is responsible for all other operating expenses.
Double Net Lease: Here, the tenant pays the leased property insurance and taxes. The landlord pays for all other operating expenses.
Triple Net Lease: The tenant has to pay the base rent plus property insurance, taxes, and maintenance costs. The landlord pays for the property’s structural repairs and capital improvements. Also known as NNN leases, the triple net lease is often used for properties with long-term tenants. Triple net leases can be particularly appealing to investors engaging in 1031 exchanges as long-term leases provide stability and reduce the risk of prolonged vacancies, ensuring a consistent income stream. When considering replacement properties for a this type of exchange, investors often seek properties with reliable, long-term tenants to minimize the likelihood of rental income interruptions, therefore protecting their dst 1031 investments.
Investing in Net Leases
Net leases are attractive to landlords because a portion of the operating expenses are shifted the tenant, reducing the landlord’s overall costs. This can make net lease properties more attractive to investors, as they can provide a higher return on investment over properties with gross leases – where the landlord pays all operating expenses.
Net lease properties typically have creditworthy tenants with long-term leases, which can provide a stable income stream for the investor. Additionally, net lease properties often have a low vacancy rate, which can further bolster the income stream.
What are Net Lease Investments?
As the name implies, net lease investments refer to investments in properties leased under a net lease agreement. These investments can take the form of direct ownership of a property, or indirect ownership through a real estate investment trust (REIT) or other investment vehicles.
Pros of Net Lease Investments
Net lease investments offer several potential benefits to investors:
- Earn Passive Income
One of the main benefits of net lease investments is the ability to earn passive income without the responsibilities of direct property ownership. Since the tenant is responsible for most of the property expenses, the investor does not have to worry about day-to-day property management and upkeep. This can be especially appealing to investors who may require more time or expertise before managing property themselves.
- Tax Benefits
Net lease investments can also offer tax benefits. For example, net lease properties may be eligible for a 1031 Exchange, a clause allowing deference of capital gains taxes associated with selling a commercial property by reinvesting the proceeds into a similar investment.
- Potential for Appreciation
Net lease properties may appreciate over time, as the value of commercial real estate tends to increase. This can provide an additional source of return for investors.
Cons of Net Lease Investments
Investors need to consider the potential risks and drawbacks of net lease investments carefully. For example:
- Tenant risk: The success of a net lease investment is heavily dependent on the creditworthiness and financial stability of the tenant. The investor’s income stream may be disrupted if the tenant goes bankrupt, or fails to pay rent.
- Interest rate risk: Net lease investments may be vulnerable to interest rate changes. The value of your asset or investment may decline if interest rates rise, as noted in the New York Times.
- Inflation risk: Net lease investments may be affected by inflation, as rent payments may not keep pace with rising costs. This can erode the asset’s value over time.
- Property risk: The property’s value may decline due to physical deterioration, local real estate market changes, or other factors. All of which can negatively impact the value of the net lease investment.
Overall, net leases and net lease investments can be lucrative opportunities for investors seeking passive income and the potential for capital appreciation. However, it’s important to carefully consider the potential risks, tenant creditworthiness, and property location. With proper due diligence and a long-term investment horizon, net lease investments can be valuable to an investment portfolio.