The Hidden Peril’s of a Triple Net Lease

For owners and investors, the popularity of triple net leases has brought obvious benefits in the way of managing, administering, and investing in commercial real estate. In short, the triple net lease puts the operating burden on the tenant, with the tenant responsible for payment of real estate taxes, building insurance, and certain operating costs and repairs associated with their occupancy of the building. There are typically exclusions to the lease that the owner is responsible for, but by and large, day-to-day operation largely falls on the tenant.

The great temptation with a triple net building, especially single tenant or big box retail, is to purchase the property, negotiate and sign the lease, celebrate, and then count on the tenant to maintain and operate the building for the next five to ten years. As an owner, you have basically entrusted your most valuable asset to the care and responsibility of the tenant. Sometimes this works and other times it does not.

The major risk with this approach lies in the long term maintenance of the high value building systems. From a mechanical perspective, is the tenant responsible for taking care of the chiller, the cooling tower, boiler, heat pumps, roof-top or make-up air units? If so, what are your assurances that the equipment will be maintained over the life of the lease? Alternatively, what is the replacement cost if it is not maintained? And, what is your plan to monitor the maintenance over the life of the lease? When structuring the lease, it is imperative that the lease addresses issues of care and standards to which the tenant is required to maintain these assets.

Another closely related problem/issue occurs when a tenant builds out their own space. There are a number of considerations under this scenario including; liens, architectural drawings, permitting, indemnification and insurance. To protect against liens, the owner or manager will need to post the premises for non-liability to protect the building against liens by subcontractors that have not been paid by the tenant. Additionally, building code violations are an issue if the tenant builds out their own space and has not obtained the required permits from the City. With respect to construction, the lease should require the tenant to provide related architectural drawings and submit them to the owner/manager for approval prior to the commencement of work. It should also be a requirement of the lease that the tenant hire a licensed, reputable general contractor for the project.

And finally, from a third party liability standpoint, it is critical that the tenant submits a Certificate of Insurance naming the property management company and owner as additional insured. The lease should also have language that properly indemnifies the owner/manager in the event of any law suits arising out of the project.

There are basically two solutions to these very important and potentially costly issues. The first would be to take these items out of the hands of the tenant entirely. When negotiating and structuring a lease, these items might be better left as a responsibility of the owner or manager, and billed back directly to the tenant. Or, as an owner/manager, you might elect to leave the mechanical maintenance and construction in the hands of the tenant, and then monitor the process closely throughout the term of the lease. Either way, these are important considerations that can have a substantial downside, both in terms of cost and compliance that could adversely impact the value of the building.

By

Rick Dassow

Chief Operating Officer

CMI Mechanical