Top 6 Terms You Should Know Before Investing in net lease commercial real estate

Website: DAJK GROUP

1. Net Lease: A provision that requires the tenant to pay a portion or all of the taxes, fees and maintenance costs for the property in addition to rent. Net lease requirements are most commonly used with commercial real estate.

2. Single Net: Lessee accepts to pay a monthly base rent and agrees to pay the property taxes. The owner is accountable for all other operating expenditures of the property.

3. NN: An agreement in which the tenant is responsible for both property taxes and premiums for insuring the building. Unlike a single net lease, which only requires the tenant to pay property taxes, a double net lease passes more expenses along in the form of insurance payments. The landlord is still held responsible for structural maintenance expenses. Each month, the landlord receives the base rent plus the additional payments. Double net leases are most commonly found in commercial real estate.

EXPLAINS ‘DOUBLE NET LEASE’

For commercial properties with multiple tenants, such as a shopping mall, taxes and insurance fees may be assigned to the individual tenants on a proportional basis. Even if property taxes and building insurance premiums are considered the responsibility of the tenant, owners of commercial property should have property taxes passed through themselves in order to ensure that they are aware of payment issues.

4. NNN: A lease agreement that designates the lessee (the tenant) as being solely responsible for all of the costs relating to the asset being leased in addition to the rent fee applied under the lease. The structure of this type of lease requires the lessee to pay for net real estate taxes on the leased asset, net building insurance and net common area maintenance. The lessee has to pay the net amount of three types of costs, which how this term got its name.

EXPLAINS ‘TRIPLE NET LEASE’

For example, if a property owner leases out a building to a business using a triple net lease, the tenant will be responsible for paying the building’s property taxes, building insurance and the cost of any maintenance or repairs the building may require during the term of the lease. Because the tenant is covering these costs (which would otherwise be the responsibility of the property owner), the rent charged in the triple net lease is generally lower than the rent charged in a standard lease agreement.

5. CAP Rate: Rent and capitalization rate are both factors that determine whether a real estate purchase is a wise investment. Rent is the monthly payment from the tenant(s), measured in currency. Capitalization rate, sometimes called cap rate, is a percentage that represents the return on investment or ROI. The rate of ROI takes into account both variable and fixed costs. Rent is one part of the capitalization rate. Other factors include the amount of time a unit may remain unoccupied, the cost of repairs, depreciation and any other variables that are subtracted from the income. The result is divided by the total cost of the building to calculate the rate.

Landlords and even some property management companies will look at the capitalization rate as the main factor in determining whether they should get involved in a potential deal. It is important information to have when deciding on residential, commercial or even industrial investments. The rate can be applied to any asset allocation that is intended to be occupied by tenants.

Real estate investment information is vital for every person who is interested in portfolio diversification. No matter what acquisition strategy an investor is using, he or she should know the cap rate and other basic data prior to making an offer on a rental property. An understanding of real estate economics helps investors find the few good deals in a vast, rapidly changing market.

Knowing the capitalization rate also helps investors choose the right strategy for their purchases. They may decide to buy and hold, short sell or pick up foreclosures from a Multiple Listing Service. Taking the right approach can save investors from making huge mistakes that could cost them a fortune.

6. NOI (Net Operating Income): A calculation used to analyze real estate investments that generate income. Net operating income equals all revenue from the property minus all reasonably necessary operating expenses. Aside from rent, a property might also generate revenue from parking and service fees, like vending and laundry machines. Operating expenses are those required to run and maintain the building and its grounds, such as insurance, property management fees, utilities, property taxes, repairs and janitorial fees. NOI is a before-tax figure; it also excludes principal and interest payments on loans, capital expenditures, depreciation and amortization.

EXPLAINS ‘NET OPERATING INCOME – NOI’

NOI appears on the property’s income and cash flow statements. If the total is negative, it is called a net operating loss (NOL). NOI is considered less vulnerable to manipulation than some other figures because it can only be increased by raising rents and associated fees or by decreasing reasonably necessary operating expenses. NOI is not the same as taxable income or cash flow. The difference between NOI and EBIT is non-operating income.

The “reasonably necessary” criterion for operating expenses means property owners might adjust some of their actual expenses up or down. If the owner provides one tenant with free rent, valued at $12,000 a year, in exchange for acting as property manager, but it would cost $24,000 to hire a professional manager on the open market, the owner can subtract the “reasonably necessary” cost of $24,000 from revenue rather than the actual cost of $12,000.

NOI helps owners and potential owners of retail buildings, office buildings and residential single- and multi-family properties to calculate several helpful ratios. NOI is used in determining the capitalization rate, which helps determine the property’s value and helps real estate investors compare different properties they might be considering buying or selling. For financed properties, NOI is also used in the debt coverage ratio (DCR), which tells lenders and investors whether a property’s income covers its operating expenses and debt payments. NOI is also used to calculate the net income multiplier, cash return on investment and total return on investment.

WHAT IS TRIPLE NET LEASE COMPARED TO OTHER FORMS OF COMMERCIAL INVESTMENTS?

Compared to office, warehouse, storage facilities, parking lots, apartments and other forms of commercial investments, triple net leases are by far the most stable and less burdensome of the opportunities available. Most of the ventures mentioned above have business related and management associated with their financial outcome. Gross leases and modified gross leases associated with most office and industrial buildings involve landlord responsibilities under various conditions. These entities have numerous obligations for the landlord to oversee or pay. When many duties or responsibilities are passed on to the investor, a much larger return should be expected for the work and financial burden placed on the landlord. Most of these types of investors are younger in age and can tolerate the various problems that occur monthly. The baby-boomer’s and older investors ready to retire, have little desire to be responsible for all of these matters and prefer a smaller return that is safer and less stressful.