A common concern many individuals have about buying real estate for investment is the potential time and cost of maintaining the property. Not everyone has the tools, expertise or inclination to fix leaky faucets, clean soiled carpets or plow a snow-filled parking lot in the wintertime. Further, it may not be practical to undertake these responsibilities for an investment property located outside of your geographical boundaries.
One possible solution is to hire a property manager – an individual or company specializing in handling the day-to-day operations of rental properties. Property managers may be national, regional or local and they often specialize in particular asset classes (i.e., multifamily, medical office). A good property manager can help you to retain your existing tenants by professionally and proactively addressing their needs, in addition to maintaining your property efficiently day to day. Of course, you have to pay for this service, typically about 3 percent of the property’s gross revenue, which will reduce your net cash flow.
Another alternative is to invest in a single-tenant triple-net (NNN) property. A triple-net lease provides that the tenant is responsible for payment and performance of his or her own property maintenance, in addition to payment of all taxes, insurance and other operating expenses for the property. The owner of a single-tenant NNN lease property, therefore, can enjoy the benefits of property ownership without significant burdens of property management or the costs of an outside management company.
NNN does not mean that there are no landlord responsibilities whatsoever for a NNN property. The landlord will be responsible for servicing any mortgage loan on the property, keeping the property leased, collecting rent from the tenant, and ensuring that the property taxes are actually paid (even if the tenant is the party making the payments). The owner would also be involved in any insurance-related issues, as well as the replacement of any major building systems, such as HVAC or the roof. However, there is little to no landlord involvement on daily operational matters, making single-tenant NNN properties good “armchair investments.”
The operation of a commercial NNN property is not quite as hands-off if there are two or more tenants at a property, even if all of the leases are triple-net. That is because multi-tenant buildings will almost always have at least some common areas, such as a parking lot or lobby, or utilities for the property that are not separately metered for each tenant. The tenants will still be responsible for maintaining their own leased premises, and for payment of their share of common area operating expenses (CAM), taxes and insurance, but there will typically be some degree of expense proration and management of the common areas to be done by the landlord, in addition to the aforementioned responsibilities of ownership for a single-tenant building. Assuming, however, there are a small number of tenants, a NNN property with two-three strong commercial tenants may still be an attractive investment with minimal landlord work.
There are also commercial leases that are double-net (NN), where the landlord is responsible for maintaining the roof, building structure and exterior areas, while the tenant is responsible for interior maintenance as well as insurance and property taxes. These types of properties are also excellent investments for landlords who do not want a lot of hands-on management obligations, especially for newer construction where the roof is covered by a warranty.
In sum, it is possible to enjoy the benefits of owning investment real estate without having to contribute your own sweat equity to maintain the property. Understanding the nature of the landlord’s and tenant’s obligations under the lease will help you evaluate the degree of complexity and management costs of a prospective real estate investment.
Tracy is a Principal at Syndicated Equities where she helps high net worth individuals and family offices to profitably invest in real estate. She also assists investors in identifying appropriate replacement property to complete tax-deferred exchanges under Section 1031 of the Internal Revenue Code. Drawing upon her 20 years of legal experience in the areas…
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