By Gary Tasman

Earlier this year, our article “7 Signs You Need a Professional Property Manager” outlined several red flags that commercial real estate owners should watch for when attempting to manage their own investment properties. One of the most concerning red flags is a property owner who doesn’t know what to charge his or her tenants.

Setting a budget for a rental property is a complex issue that is best handled by professionals — not only for the benefit of the owner, but also for the tenants. Property managers need to understand the relationships between rent, Common Area Maintenance (CAM), sales tax and other variables like utility costs to set their budgets appropriately and keep their properties desirable for commercial tenants.

One of the most common issues we see at Cushman & Wakefield | Commercial Property Southwest Florida is owners who offer gross leases rather than renting space using a triple net (NNN) lease. As property managers, this is one of our most important strategies. We have converted hundreds of gross leases to triple net, and in the long run benefiting both the landlord and the tenant.

Gross Versus Triple Net Leases

Many property owners without strong accounting support use gross leases to simplify the accounting process. In a gross lease the tenant pays the same amount every month for the term of their lease, and this lump sum includes rent, CAM, insurance, and property taxes. Depending on the terms of the agreement between landlord and tenant, a gross lease may also include utilities. The property owner bears the expense of the operating and maintenance costs.

Conversely, a triple net lease divides these different expenses into base rent and additional expenses. While the base rent stays constant in accordance with the terms of the lease, the CAM can fluctuate annually depending on unforeseen repairs, labor and materials costs, and contributions to maintenance reserve accounts. Insurance rates and property taxes can also fluctuate regularly.

Benefits of Triple Net Leases

When we begin managing a property with a gross lease, we almost immediately begin the transition to triple net. This process begins with a five-year capital improvement strategy and budget, which plans for major repairs and replacement of outdated systems or equipment. The goal is to prevent surprise expenses and establish reserves for upcoming capital improvements. The capital improvement budget is then used as part of the CAM calculation.

How does this process benefit the property owner? Simply put, a well-budgeted property with a triple net lease program assumes less risk. Unplanned expenses on a large building — like a new roof or replacement of an HVAC system — can cost hundreds of thousands of dollars. If an owner has tenants locked into a five-year gross lease, there’s no flexibility in rent to cover these expenses, and the owner is left with a large bill and no additional income. Conversely, if that property owner is following a budgeted capital improvement schedule and has tenants on a triple net lease, many of these expenses can be paid through CAM reserve funds and without the need for special tenant assessments. This allows owners to realize the highest potential value for a property.

A well budgeted property with a triple net lease can also be more competitive in the market. Although CAM rates can fluctuate from year to year, tenants will appreciate leasing a space with healthy reserves. Triple net leases also benefit tenants because these properties tend to be better maintained. Owners with gross leases often delay maintenance and repairs because of cash flow concerns, in the long run leading to a less desirable property.

Converting Your Property to NNN

Converting your commercial property to a triple net lease will make your commercial assets more desirable for both leasing and potential sales. However, the conversion can be a lengthy process — it doesn’t simply happen overnight. Owners need to ride out their tenants currently renting under a three-year, five-year, or longer gross lease arrangements. They also need to be committed to the capital improvement budget and planning process to maximize their return on investment.

Fortunately, property owners don’t need to — and shouldn’t — go it alone. The full service property management professionals at Cushman & Wakefield | Commercial Property Southwest Florida are prepared to assist with all aspects of operations and financial services as you maximize the value of your commercial rental property. From inspections, planning and budgeting to vendor selection, financial analysis and compliance, the property management team at CPSWFL will work with you to make this transition as smooth as possible. Learn how CPSWFL can help you achieve your business goals and objectives by clicking the form below.

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