What Is Net Lease? The Key To Passive Real Estate Investing

The following post was written and/or published as a collaboration between Benzinga’s in-house sponsored content team and a financial partner of Benzinga.

In commercial real estate there are two different categories of leases: gross leases and net leases. A gross lease is where the tenant pays a flat fee to the owner of the building and the owner is responsible for paying all the costs associated with a property. A net lease where the tenant pays the rent and additional expenses associated with the property.

Single, Double, and Triple Net Leases

Before we dive into the benefits of a net lease structure it is important to understand the three different net lease structures.

A single net lease (N) structure requires the tenant to pay the rent and taxes associated with the property. This leaves the landlord responsible for insurance and maintenance associated with the property. Single net is the least common net lease structure.

In a double net lease (NN) structure, the tenant is responsible for rent, property taxes, and insuring the property, leaving the landlord responsible for maintenance.

A triple net lease (NNN) requires the tenant to pay rent, property taxes, insurance, and maintenance. This leaves the landlord with little to no responsibilities related to the property. NNN agreements are the most popular because they provide benefits to the property owner, the developer who builds the property and the retailer who leases the property.

Everyone is a Winner.

The benefits of a net lease to the owner (investor) of a property are obvious as they are left with very little responsibility associated with the property. Net leases also tend to be long term leases ranging from 10-20 years. This coupled with the removal of responsibilities provides an investor with a stable, predictable, and consistent source of passive cash flow. While sitting back and collecting a monthly rent check, investors also benefit by building equity in the property and by being able to lower their tax burden by depreciating the asset over time.

Developers are also winners in the world of net lease real estate. Developers can build a property, lease it out to a tenant, sell the property to an investor and then reinvest the capital into their next property without worrying about actively managing the property after construction. Developers also benefit from being able to do a 1031 exchange in which they can defer their capital gains taxes on a property by reinvesting the earnings into a new piece of real estate.

But how could the tenant possibly benefit if all the expenses land in their lap? Net lease structures allow businesses to free up capital by selling their underlying real estate. This is commonly done through what is called a sale-leaseback. This is where a retailer sells their store to an investor, then immediately lease the property back from the investor. This process can provide a company millions of dollars’ worth of liquidity to reinvest back into their business. Because net leases tend to be for long term agreements and because they assume most of the responsibility, it also provides them lower costs compared to that of a gross lease.

Who Invests in Net Lease?

Investing in net lease is so unique because of its flexibility. With net lease real estate, you do not have to be a real estate professional or a large real estate firm to invest. Net lease properties attract everyone from an individual investor to the largest financial institutions in the world. Many high-net-worth individuals invest in net lease real estate to garner the tax benefits. Pension funds and large investment firms will buy a large portfolio of net leased properties valued over $100 million. But how does the average person invest in net lease real estate? The answer is Real Estate Investment Trusts (REITs).

The great thing about REITs is they are required to distribute at least 90% of taxable income to shareholders through dividends. This allows anyone to own stock in a REIT and collect “rent” on a portfolio of properties in the form of a dividend. I am sure it doesn’t’ come as much of a surprise that some REITs specialize in net lease properties. Some of them buy net lease properties across all real estate types while others will focus on retail or commercial properties. REITs allow anyone to invest in real estate and provide a fantastic rate of return in the process. According to JP Morgan, going back to 2000, REITs are the best performing asset class, up 12% on an average annual basis.

How Many REITs Are Net Lease REITs?

COVID-19 has brought about a lot of uncertainty not only into investing, but into our everyday lives. The real estate industry has been suffering as stores, restaurants and hotels have seen revenues drop to zero overnight. Despite all the financial turmoil the pandemic has brought, net lease REITs have been among the leaders in raising dividends during the pandemic. There were 41 REITs that increased their dividends during 2020, 8 of them were net lease REITs: Agree Realty Corporation ADC, Four Corners Property Trust FCPT, Getty Realty GTY, Alpine Income Property Trust PINE, STORE Capital STOR, National Retail Properties NNN, Realty Income O, and WP Carey Inc WPC. Of these 8 REITs, two provide the advantage of a monthly dividend: Agree Realty Corporation and Realty Income.

When deciding which REIT to invest in it is also important to consider the quality of the portfolio. For example, the percent of investment grade (IG) tenants inside a REIT’s portfolio has a direct correlation to the quality of that portfolio. The leaders from the list above in IG include Four Corner  at 71%, Agree Realty at 67%, and Realty Income at 51%.

Only one question now remains: which REIT are you going to buy first?

The preceding post was written and/or published as a collaboration between Benzinga’s in-house sponsored content team and a financial partner of Benzinga. Although the piece is not and should not be construed as editorial content, the sponsored content team works to ensure that any and all information contained within is true and accurate to the best of their knowledge and research. This content is for informational purposes only and not intended to be investing advice.