Net Lease

Contractual agreement

Author: Rohan Arora
Rohan Arora
Rohan Arora
Investment Banking | Private Equity

Mr. Arora is an experienced private equity investment professional, with experience working across multiple markets. Rohan has a focus in particular on consumer and business services transactions and operational growth. Rohan has also worked at Evercore, where he also spent time in private equity advisory.

Rohan holds a BA (Hons., Scholar) in Economics and Management from Oxford University.

Reviewed By: Elliot Meade
Elliot Meade
Elliot Meade
Private Equity | Investment Banking

Elliot currently works as a Private Equity Associate at Greenridge Investment Partners, a middle market fund based in Austin, TX. He was previously an Analyst in Piper Jaffray's Leveraged Finance group, working across all industry verticals on LBOs, acquisition financings, refinancings, and recapitalizations. Prior to Piper Jaffray, he spent 2 years at Citi in the Leveraged Finance Credit Portfolio group focused on origination and ongoing credit monitoring of outstanding loans and was also a member of the Columbia recruiting committee for the Investment Banking Division for incoming summer and full-time analysts.

Elliot has a Bachelor of Arts in Business Management from Columbia University.

Last Updated:October 10, 2023

What Is A Net Lease?

A net lease is a contractual agreement in which the landlord of the property (lessor) allows another party (lessee) to use the property for a fixed period in exchange for payment of property tax, rent, and insurance fees.

In this type of lease, the lessee, who is the tenant, must pay for the rent and other additional costs as if he was the landlord of the property. These additional costs include rental, property, insurance, and maintenance fees. 

This lease is most used for Commercial Real Estate (CRE). A piece of property known as commercial real estate (or CRE) is utilized solely for professional or business purposes or to provide cash flow for the landlord or lessee.

The rules that are stated in the contract must not be broken, otherwise, there will be consequences, and legal action will have to be taken. 

There are three types of net leases: single, double, and triple. The different types of leases work in different ways. 

In the single net lease, the tenant must pay only for property taxes, along with the rent of the property. 

This lease is also known as the ‘N’ lease. If there are multiple tenants on the property, then the property tax will be divided equally, usually based on square footage or any other metric, such as rent.

In a double net lease, the tenant must pay for property taxes and insurance premiums, along with the rent. This is also known as an ‘NN’ lease. 

This type of lease is most often found in commercial real estate. The landlord calculates the property taxes and insurance fees based on the space used. 

In the triple net lease. The tenant must pay property tax, insurance premiums, and maintenance and repairs. This is also known as an ‘NNN’ lease. As all the additional payments are charged to the tenant, the landlord charges a considerably lower rent.

Key Takeaways

  • A net lease is a contractual agreement where the tenant (lessee) pays not only the rent but also additional costs such as property taxes, insurance fees, and maintenance costs.
  • There are three types - Single Net (N), Double Net (NN), and Triple Net (NNN), each specifying the extent of additional costs tenants are responsible for, influencing rent amounts.
  • Tenants under net leases have control over costs, promoting efficiency in resource use, but they are also liable for property-related fines and liabilities.
  • Net leases offer stable income, reduced management duties, and potentially lower financial risks, making them attractive investments in the commercial real estate sector.
  • Both landlords and tenants should carefully assess the terms of net lease agreements, balancing benefits and responsibilities, to ensure a mutually beneficial arrangement.

Understanding Net Lease

Under this lease, the lessor (the landlord of the property) allows the lessee (another party) to use the property in exchange for a stated rate, along with property taxes, insurance fees, and maintenance costs.

It is most used for Commercial Real Estates (CRE). A piece of property known as commercial real estate (or CRE) is utilized solely for professional or business purposes or to provide cash flow for the landlord or lessee.

In this type of lease, the lessee, who is the tenant, must pay for the rent and other additional costs as if he was the landlord of the property. These additional costs include rental, property, insurance, and maintenance fees. 

These are expenditures that a landlord would normally pay for the operation, upkeep, and use of the property. This lease enables business landlords to reduce their property expenses by passing them on to the tenant.

When property landlords and tenants enter a contractual agreement under this lease, the property landlord (lessor) charges the tenant (lessee) a rental fee less than the gross lease because the tenant must pay for additional costs, such as maintenance costs, insurance fees, and property taxes.

A building with this type of lease in a prime location with high-credit-rating tenants on long-term leases can be a great investment. Companies aiming to optimize earnings are finding net-lease financing to be an excellent solution that benefits both the tenant and the real estate operator. 

How Net Lease Works

A lease works when there is a contractual agreement between two parties, namely, the lessor and the lessee. The lessee must provide a certain rental fee alongside other additional payments, such as maintenance costs, property tax, and insurance fees.

Property landlords that do not want the hassle of additional costs usually rent out their property under this form of lease.

In practice, this lease is commonly used for commercial real estate transactions in which the tenant (lessee) pays rent in addition to the landlord's (lessor's) other operational expenditures. 

This simplifies the management procedure for the landlord, which may be advantageous if the landlord manages many properties.

This lease is used for commercial purposes and personal property only. The rules and duties stated in the contract should not be broken, otherwise, there will be consequences, and legal action will have to be taken. 

From the lessee's standpoint, the amount that the landlord gives up from the rent must be big enough to cover maintenance and other administrative expenditures that the lessee is exposed to. 

Tenants are driven to lower their utility use, but landlords have little immediate motivation to conduct energy efficiency retrofits beyond the long-term worth of their property, and there are no quick means to recuperate their costs. 

Companies aiming to optimize earnings are finding net-lease financing to be an excellent solution that benefits both the tenant and the real estate operator. 

Gross Lease Vs. Net Lease

gross lease is a contractual agreement in which the landlord of the property (lessor) allows another party (lessee) to use the property for a fixed period in exchange for payment. Only the rental fees must be paid by the lessee. 

The payments are done either weekly, monthly, or annually. The rent is fixed and does not change due to other additional costs increasing or decreasing, like utilities. These costs are borne by the landlord of the property and not the tenant. 

The landlord is responsible for all costs, liabilities, and fines associated with the property. These payments are commonly made with the rent given by the tenant. 

Depending on the circumstances, gross leasing can be carried out in a variety of ways. It can be put into an absolute gross lease agreement or adjusted to incorporate the best of both gross- and net-lease features.

Both the landlord and the tenant benefit from this lease. The tenant must pay a predetermined fixed rate every month, and budgeting these costs becomes easier. This lease can be beneficial to the landlord too, as the landlord can gain benefits from opting for an energy-efficient operation.

On the other hand, the net lease is a contractual agreement in which the landlord of the property (lessor) allows another party (lessee) to use the property for a period in exchange for a stated amount.

The lessee has to pay rental fees along with additional costs, like insurance fees, property taxes, and maintenance costs.

The tenant not only has to pay for rental costs but also additional costs. As the tenant must pay all of these costs, they have control and are motivated to use utilities efficiently. 

On the other hand, the landlord does not have to worry about such additional costs, since the tenant will incur them per the agreed-upon terms. 

Types of Net Leases

The various types of net lease are:

1. Single

This type of lease is used in a commercial real estate agreement between the lessor and lessee to pay property tax in addition to rent. It is also called an ‘N’ lease.

In this lease, the tenant only pays for one category of additional payments. This lease focuses on property tax as the additional payment. It is not a common lease in the rental world.

If there are multiple tenants on the property, then the property tax will be divided equally, usually based on square footage or any other metric, such as rent.

Advantages

  • From the landlord's point of view, it provides administrative relief, as this lease makes the tenant responsible for managing the property taxes.
  • From the tenant's point of view, rent may be reduced for the added convenience to the lessor.

Disadvantages

  • Even though the tenant is responsible for managing the property tax costs, the landlord is still responsible for other costs of the property.
  • It is time-consuming, as the landlord must make a detailed plan.

2. Double

In this lease, the tenant must pay property tax and insurance fees, in addition to rent. This lease is also called the ‘NN’ lease. This type of lease is most often found in commercial real estate. The landlord calculates the property taxes and insurance fees based on the space used.

Advantages

  • From the landlord's point of view, it is easier to control expenses.
  • From the tenant's point of view, it can lower monthly payments.

Disadvantages

  • From the landlord's point of view, unexpected costs are possible.
  • From the tenant's point of view, the tenant must do a cost analysis on the insurance fees and property tax to ensure they are not overpaying for rent.

3. Triple

In this lease, the tenant must pay for rent, property taxes, insurance premiums, and maintenance and repairs. This lease is also called the ‘NNN’ lease. 

As all the additional payments are charged to the tenant, the landlord charges a considerably lower rent. 

Advantages

  • Minimal landlord responsibilities, as most of the payments, are handled by the tenant.
  • From the landlord’s point of view, passive income can be earned reliably.
  • From the landlord’s point of view, it is a low-risk investment as all the costs associated with the property are paid by the tenant.
  • The landlord's duties are reduced, as all costs associated with the property are under the responsibility of the tenant.

Disadvantages

  • There is a risk of turnover.
  • The landlord has less leverage to increase the rent, as most of the additional payments are paid by the tenant.
  • When the tenant is responsible for the costs associated with the property, they are also responsible for all the liabilities and fines.

Net Lease Calculation 

To demonstrate the net-lease calculations, pretend you own a modest commercial facility with the following net-lease tenant,

The costs associated with the property are as follows:

  • Property tax = $1,000
  • Insurance premiums = $500
  • Maintenance costs = $400
  • Rent = $2,000

Under the N lease, the tenant must pay only for property tax and rent. So, only $3,000 will be paid by the tenant and the rest will be paid by the landlord. 

Under the NN lease, the tenant must pay for property tax, insurance premiums, and rent. So, only $3,500 by the tenant, and the rest will be paid by the landlord.

Under the NNN lease, the tenant must pay for all the costs associated with the property, along with the rent. So, $3,900 will be paid by the tenant and nothing will be paid for by the landlord. 

Net Lease FAQs

Researched and authored by Ajay Kumar SahooLinkedIn

Reviewed and edited by James Fazeli-Sinaki LinkedIn

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