Commercial real estate investors are generally responsible for the maintenance and repair of the buildings they purchase unless there’s an absolute net lease in place. Using an absolute net lease shifts these responsibilities onto the tenant, which can result in easier operations, more lenient financing, and several other benefits.
What is an Absolute Net Lease?
An absolute net lease is one of the strictest commercial leases, and it tends to be the most pro-landlord type of lease.
This lease requires that the tenant bears all the property expenses, not just including taxes and insurance costs. All property expenses encompass taxes, insurance, maintenance, repairs, and even structural issues that arise during the lease term. Tenants become responsible for everything from the cracked floor tile to the caving-in roof.
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Absolute Net Lease vs Triple Net Lease: Key Differences
Sometimes, absolute leases are referred to as a type of triple net lease (NNN lease), but there are essential differences between the two. Namely, total leases add onto what tenants’ are responsible for in triple net leases.
In a triple net lease, tenants are responsible for property taxes, insurance, and maintenance of their leased area. Maintenance doesn’t include major repairs or structural issues, however.
In an absolute net, tenants are additionally responsible for major repairs and structural issues that arise during their lease. These costs can be substantially more than a triple net lease requires, and they’re much less limited than taxes, insurance, and routine maintenance expenses.
What are Absolute Net Leases Most Commonly Used For?
Absolute net leases are most commonly used in long-term lease arrangements for standalone commercial properties. These leases benefit investors who want a hands-off approach, leveraging their cash more than their building expertise.
Landlords might also prefer these leases if they own an older building needing some work. While tenants and landlords might disagree about what constitutes necessary repairs, shifting the responsibility of repair onto tenants considerably lowers a landlord’s risk when leasing out deteriorating properties.
In some cases, absolute net leases are used if a tenant leases land only. The tenant is generally already responsible for building maintenance if there are improvements on the property, as they own the building. Landlords might remain responsible for the minimal maintenance that the land requires (e.g. removing dead trees). Instead, They might shift maintenance responsibilities onto the tenant for convenience or insurance reasons.
Benefits of Absolute Net Lease to Landlord and Tenant
The absolute net lease structure offers significant benefits to landlords and some to tenants in some instances.
Benefits to Landlord
There’s no doubt that landlords see the most and biggest benefits of these landlord-friendly leases:
- Predictable Finances: Repairs are some of the most unpredictable, and potentially most expensive costs that come with owning a property. Making the tenant responsible for these allows the landlord to much more easily predict operating expenses, net operating income, cash flow and returns.
- Management Required: Not having to deal with repairs makes it much easier for the landlord to manage the property. This allows landlords with funding to maximize their cash, without needing the time or expertise that building maintenance requires.
- Reduced Risk: When the landlord isn’t responsible for repairs, they greatly reduce their risk exposure. There’s no ceiling to how much major structural repairs could cost
- Easier Financing: With the reduced risk of repairs, lenders may be more willing to work with investors on financing solutions. Lenders will usually require less previous experience from investors, and they might require less down. Lenders could want to confirm that a tenant is well-positioned to pay for repairs, however.
Benefits to Tenants
Tenants see fewer benefits from absolute net leases, but these aren’t without some advantages that certain tenants might want:
- Control: Tenants gain more control over the property, tailoring the premises to their needs. They’re more accessible to make improvements, alter the building’s appearance, or make changes.
- Lower Rent: By taking on the financial costs of major repairs and structural issues, tenants typically get much lower rents for these leases. Due to their financial burden, tenants may negotiate a lower rent.
- Longer Leases: Taking on the risk of long-term maintenance issues can often get tenants a longer lease, potentially a much longer lease. This can be especially important to tenants who require extensive build-outs or are known for their particular location.
Disadvantages of Absolute Net Lease
However, this structure isn’t without its downsides, and these can be significant.
Landlords will first find that insisting on an absolute net lease dramatically diminishes the number of tenants willing to sign. Even those who might do a triple net lease may not want the additional responsibilities of an absolute net.
Landlords will also likely get significantly lower rents for the lease. While risk is reduced and potential expenses mitigated, potential returns are likewise reduced if a building remains in good condition.
These leases are often much longer than others, which could prevent landlords from taking advantage of increasing rent rates in the future. Again, this can impact potential returns.
Should a tenant be unable or unwilling to pay for repairs, the resulting disagreement can become expensive to settle. Landlords should make sure tenants have established financial reserves. They also should pursue renegotiating a lease before its end, as tenants will be much less likely to make structural repairs when their lease is nearly over.
Additionally, these leases are generally only viable when one tenant leases a building. If multiple tenants have spaces within the same building, who bears what share of major and structural repairs can become unclear. Issues become even more problematic if one tenant won’t or can’t pay their portion of a major repair.
Other Implications of Absolute Net Leases
The legal costs of absolute net leases must not be overlooked, as they can result in costly litigation if repairs are expensive enough. Carefully detailing responsibilities within a lease can minimize the risk of a lawsuit over repairs.
The building condition also shifts somewhat to the tenant’s discretion. Tenants might be more willing to repair visible issues that customers see, but they may be less inclined to make structural repairs that don’t directly affect appearance or operations.
Locking a tenant into a long-term lease could affect the future sale price of a property. Other investors might not want to purchase the property if a tenant’s guaranteed below-market rent for a long time.
How to Maximize the Benefits of Absolute Net Lease
Maximizing benefits requires a strategic approach. Landlords should thoroughly vet tenants’ financial positions and ensure leases are written.
Landlords should also pursue these leases only with long-term clients. They’re best when the landlord and tenant have an established relationship.
If you have a standalone investment property that one good tenant occupies, an absolute net lease might be a good choice. Approach the tenant about this option, pointing out the potential for a lower and longer lease.