NNN CHARGES

NNN CHARGES: COMMON PITFALLS TO AVOID

If you’re a commercial real estate tenant or investor, chances are you’ve encountered the term “NNN” before. But what exactly do these three letters entail, and why are they so crucial to understand?

While NNN leases offer benefits for both landlords and tenants, navigating the complexities of these arrangements can be challenging.

Whether you’re a seasoned commercial real estate professional or just dipping your toes into the market, understanding NNN charges and the potential pitfalls associated with them is essential for making informed decisions and safeguarding your financial interests.

Table of Contents

What are NNN Charges?

NNN stands for “Triple Net Lease,” a type of lease agreement commonly used in commercial real estate. In an NNN lease, the tenant is responsible for paying not only the base rent, but also the net costs associated with the property. These factors include Common Area Maintenance, Property Taxes, and Property Insurance. 

NNN Charges are devised with the intent to pass on the maintenance of common areas, management, taxes, and insurance to commercial property’s tenants based on their proportionate share. 
 
Landlords typically calculate NNN charges based on the total expenses incurred for property taxes, insurance, and maintenance, divided by the total leasable square footage of the property.
 
Managing the landlord’s risk and tenant’s pass throughs plays a key role in negotiating a NNN lease.

NNN Charges: Common Area Maintenance

A large part of negotiating a commercial lease can be negotiating what common area charges (CAM charges) are included and if the tenant has a cap on charges. Costs typically covered in CAM charges include property management fees, common area maintenance, landscape and mowing, exterior lighting, signage, etc. 

Sophisticated tenants will try to negotiate CAM charges, caps on CAM charges and what can be included. Terms negotiated in the lease can bind a Landlord for many years and affect NOI of the property. Knowing what the actual costs are and how much to negotiate is key to maximizing your return.

Annual Reconciliation of CAM Charges

Landlords have a deadline each year to reconcile NNN charges, provide an itemized statement of the operating costs for the preceding year, compute new NNN charges and invoice for the amounts owed (or refund overpayments). With a commercial property with multiple tenants, it’s important each tenant’s reconciliation and new charges are reflective of their lease. If you have 20 tenants, they may have 20 different lease agreements! At M&D Real Estate, we specialize in making sure our management team fully understands each tenant’s lease, so our clients stay in compliance with agreements, and most especially, get the most out of their investment property.

Bookkeeping and Audits

Detailed bookkeeping may be the most important part when working with a NNN lease. It is important to have copies of every expense included in the CAM charges. This includes every mowing invoice, lightbulb changed, and trash pick up. This is important not only for reconciliation purposes but also because tenants will have the right to audit a Landlord’s records and failure to maintain those records will cost you money.

With a commercial property with multiple tenants, it’s important each tenant’s reconciliation and new charges are reflective of their lease.

NNN Charges: Property Taxes

With NNN charges, tenants are typically required to contribute towards the property taxes assessed on the leased property. This can include real estate taxes imposed by local governments based on the value of the property.

Property tax is a recurring levy imposed by local governments, payable by real estate owners within their jurisdiction. This tax is calculated as an ad-valorem tax, wherein the owed amount is a percentage of the property’s assessed value.

For many local governments in the United States, property tax receipts constitute the primary source of revenue. These funds are allocated towards financing essential services such as education, law enforcement, firefighting, infrastructure maintenance including roads, public libraries, water management, and sewage treatment, among others, all of which contribute to the welfare and development of the community.

How are Property Taxes Calculated?

The calculation of a property’s tax bill involves multiplying the local tax rate by the property’s assessed value. Depending on the property’s location, both city (or town) and county tax rates may apply to the bill, alongside additional charges like those for police and fire departments, as well as solid waste services.

Tax rates can be expressed as percentages or fractions of a dollar per every $100 of the property’s assessed value. For instance, if the county tax rate is 2%, and your property is valued at $200,000, your tax bill would amount to $4,000, representing 2% of $200,000.

Alternatively, tax rates may be indicated as a fraction of a dollar per $100 of the property’s assessed value. For example, if the county tax rate is $0.65 per $100 of your property’s value, and your property is assessed at $100,000, your tax liability would be 65 cents for every $100 of value. To calculate your total tax bill, divide your property’s assessed value by 100 and then multiply that quotient by 0.65. Thus, for a property valued at $100,000, the tax bill would amount to $650.

To gain clarity on how your tax bill is computed, you can reach out to your city or county’s tax office or an experience M&D Commercial Associate for detailed information.

Property tax is a recurring levy imposed by local governments, payable by real estate owners within their jurisdiction.

Capping Property Taxes in a NNN Lease

During lease negotiations, it’s prudent to request access to the landlord’s property tax bill from the previous year. This provides insight into the potential tax burden you may bear, at least initially. However, it’s essential to recognize that this figure is subject to change over time. Here’s why:

  1. Fluctuating Tax Rates: The tax rate imposed by the city or county can vary from year to year. Increases in tax rates directly affect the property’s tax bill. Stay informed about current tax rates by consulting your local tax division.

  2. Property Reassessment: Knowing when the property’s tax assessment was last revised is valuable. If it was recently adjusted, you might not anticipate immediate changes. However, prolonged stability in tax assessments, coupled with rising property values or landlord-initiated improvements, could signal impending tax hikes. Remain vigilant and prepared for such scenarios.

  3. Change in Ownership: A significant increase in real estate values leading to the property’s sale at a substantial profit often results in higher taxes. Despite the new owner’s obligation to honor existing leases, tenants may face inflated tax bills as a consequence.

Given these factors, securing a binding agreement that caps your tax liability at a specified amount is advantageous. This safeguard shields you from unexpected tax increases triggered by reassessments or property sales. It offers peace of mind amid potential fluctuations in property taxes, ensuring financial predictability throughout your lease term.

NNN Charges: Property Insurance

The tenant is additionally responsible for the expense of building insurance, which encompasses protection against potential structural damages. By passing on this financial obligation, the landlord safeguards themselves from unforeseen hikes in insurance costs or claims throughout the lease period.

Common Insurance Policies

Typically, the landlord will either possess or mandate you to have:

  1. Property and casualty insurance, and
  2. Commercial general liability insurance (also referred to as “third-party insurance”).

 

The landlord may already have these policies established. In such cases, you would be expected to contribute towards the landlord’s premium payments. Conversely, if the landlord lacks one or both of these policies, they are likely to insist that you acquire them. A common scenario entails the landlord maintaining their property and casualty insurance while expecting you to share the premiums but requiring you to procure your own liability insurance.

Should your landlord necessitate any of these policies, they will likely demand to be listed as an insured party and will specify minimum coverage requirements. For instance, your landlord might stipulate a general liability insurance policy with at least a $1 million occurrence limit and a $2 million aggregate limit.

The tenant is additionally responsible for the expense of building insurance, which encompasses protection against potential structural damages.

While property and general liability insurance serve as the fundamental insurance types for commercial leases, you may wish to contemplate additional insurance options for your small business. Your landlord might even mandate these supplementary coverages. Some examples include insurance for your trade fixtures and inventory, rental interruption insurance, business interruption insurance, and leasehold insurance.

Prior to engaging in lease negotiations, it’s crucial to comprehend other vital aspects of the two primary insurance types: property and general liability.

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If you’re not optimizing your expense reimbursements, it can cost you upwards of thousands of dollars each year!

M&D Property Management offers unparalleled services to Commercial Property Owners that improve your NOI and give you peace of mind. From tenant screening and leasing, to structuring expert lease agreements, annual budgeting, record keeping and detailed reconciliations, we do it all. Our promise to our clients is to keep your property well preserved and maintained, your tenants happy and their business successful, and your vacancy rates low. We will help you plan for today, tomorrow and the long-term and treat your property and bottom line as if it were our own. Our team has decades of experience in commercial property management, and our clients enjoy personalized, competent, connected management that delivers results.

Call us today if you’re interested in learning more about Property Management services for your commercial space. We can go over everything we do, our great value fee structure and explain why companies that choose M&D say they would never manage their own property or use anyone else ever again!

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