If you’ve ever owned or rented commercial property, chances are you’re familiar with the term, “triple-net lease.” This refers to the tenant’s responsibility to pay property taxes, insurance and maintenance expenses, in addition to the base rent.

In a true triple-net lease, the base rent equals the net operating income. However, many tenants and landlords are unaware of their specific responsibilities under this type of lease because the terms are ambiguous. As a result, tenants may interpret an agreement to pay for “maintenance” as being limited to operational expenses without realizing they’re responsible for capital improvements, as well.

That’s why, when I have a client who wants to invest in a tenanted, commercial property, I advise them to have an attorney review the legal documents, including existing lease agreements, most of which are triple-net. Many times I’ll refer them to Gregg Truxton, a principal in the law firm Bolanos Truxton, P.A. in Fort Myers.

Gregg is well versed in commercial leases and an expert at spotting vague language and other potential problems frequently found in triple-net agreements. He shares his insights on this subject in the following Q&A.



Q: What are the most common problems associated with triple-net leases?



I’ve reviewed a lot of contracts for clients, including those who are interested in buying commercial office or retail properties with existing leases in place. In many cases, the buyer/investor expects the leases to be triple-net, but finds that there are exceptions to the tenant’s responsibilities. Also, tenants may not realize the extent of their obligations under the lease and may be surprised to learn that they are responsible for major expenditures such as the replacement of the roof.

Well-written leases should clearly allocate the responsibilities for the maintenance of the property between the landlord and the tenant. In a true triple-net lease, the tenant is responsible for all expenses related to the property, including maintenance, property taxes and insurance, so that the rent that is paid by the tenant to the landlord would go directly to the landlord’s bottom line as his net profit. Out of that income, the landlord would pay for any debt service on the property.

However, I often see deviations in a lease that would make it something other than triple-net, particularly where capital expenses are concerned. A capital expense would include, for example, replacement of a roof or any other item with a useful life of more than one year, such as the HVAC system, mechanical systems and parking areas. A true triple-net lease would require the tenant to pay for all of the property maintenance, including the above-mentioned capital expenses.

Sometimes, the lease will provide a dollar limit on the tenant’s responsibility for major repairs. Or the lease may provide that these types of capital expenses are the landlord’s responsibility or that they are amortized over their useful life. If so, then it is not a true triple-net lease.



Q: Suppose, for instance, the HVAC system needs a new air compressor? Who would pay?



The answer depends on the language of the lease. Although a true triple-net lease would provide for the tenant to pay for this item, I see many leases that will make exceptions for major repairs or for replacement of these types of items, so that the landlord is responsible.



Q: Is it fair to charge the tenant with the full cost of replacing the roof?



The allocation of responsibility and expense is a matter of negotiation that should be considered carefully when entering into a lease. One way to mitigate the impact of these large expenses is to establish an annual reserve for deferred expenditures. For instance, at a single-tenant building whose roof has a 20-year life, each year the landlord could collect 1/20th of the cost of a new roof and place those funds in a reserve account. That way, when the time comes for a new roof, the funds are available for that purpose.

I’ve also seen some leases that require the landlord to pay for the roof replacement and then amortize that expense over the anticipated life of the new roof. But in that scenario, the landlord must come up with cash out of pocket, up front, and then recover his costs over the remaining life of the lease. In that situation, I would suggest that the landlord include interest in the repayment to cover the cost of financing. However, all of that depends upon the lease terms negotiated.



Q: Who benefits most from a triple-net lease — the landlord or tenant?



Landlords like them because they provide a predictable income stream. Conversely, tenants with triple-net leases are somewhat at a disadvantage because they’re responsible for future expenses, which are impossible to predict, or for replacing items that could outlast the term of their lease. My advice to them would be to negotiate caps on potential exposures or limitations on their responsibility for major items.

Remember, it’s all in the way the lease is written. Because the definitions in the lease are going to drive it, they all must be spelled out explicitly. You can never have too much detail.

My thanks to Gregg Truxton for underscoring the need to have at least two advisors (a broker and an attorney) involved in any real estate transaction. And if you’re an investor considering buying property encumbered by a triple-net lease, I’d say that legal advice is critical. It’s the best way to know exactly what you’re buying and whether or not the lease terms are compatible with your investment objectives.



Gary Tasman is executive director of Cushman & Wakefield’s Southwest Florida office. For more information, please contact him at (239) 489-3600 or gary.tasman@cushwake.com.