Unmasking Triple Net’s Disguises

In commercial leasing, “triple net” is market shorthand, not a defined legal term. The three nets are taxes, insurance, and maintenance, which a tenant pays in addition to base rent. How far each one reaches depends on the asset class and the market. Because triple net takes on a different disguise in each industry and market, consider the examples below, which show how the maintenance “net” is allocated between landlord and tenant in office, industrial, and single-tenant leases.

Office

In a multi-tenant net office building lease, the tenant maintains the interior of its premises. The landlord operates, maintains, and repairs the common areas, the building structure, and the base building systems, including core HVAC. The landlord recovers those costs through operating expenses, and each tenant pays its proportionate share.

Office leases typically exclude capital expenditures from operating expenses, with two common exceptions:

• Capital improvements that reduce operating expenses
• Capital improvements required to comply with laws

Sometimes the landlord will also try to include replacements (as opposed to additions or new improvements) of non-structural items in the common areas or of base building systems, such as core HVAC equipment.

Each permitted capital expenditure is amortized over its useful life. However, the landlord also is responsible for replacing the roof, foundation, and exterior walls at its sole cost, except to the extent the replacement falls within one of those capital inclusions. The tenant does not typically perform capital repairs or replacements.

Industrial

In a multi-tenant industrial project, the landlord operates the project, maintains the common areas and the building structure, and passes those costs through to the tenants. The landlord typically replaces the structural elements of the roof, foundation, and exterior walls at its sole cost.

The tenant takes on much more of the maintenance than an office tenant does. It maintains, repairs, and replaces its premises and the systems that exclusively serve them. A typical industrial form lists:

• Loading areas, dock equipment, dock doors, levelers, and overhead doors
• Plumbing, sump pumps, electrical and water lines, the fire sprinkler system, and sewer lines up to the points of common connection
• Entries, doors and door frames, ceilings, skylights, windows and window frames
• Interior walls, the interior side of demising walls, the floor slab, and the HVAC system

That obligation often includes capital expenditures whose benefit may extend beyond the term.

Sometimes the parties share capital expenditures through an amortized structure. A tenant does not want the lease to obligate it to replace an HVAC unit with one year left in the term, only to have the next tenant enjoy the benefit of its expense. Amortization limits the tenant’s cost to the portion of the useful life that falls within its term.

Single Tenant

In a single-tenant building, the tenant typically maintains, repairs, and replaces nearly everything. One drafting technique for a landlord is to state that the landlord is responsible for a short list of items, such as the roof structure, the foundation, and the exterior walls. The tenant is then responsible for everything else that is not an express obligation of the landlord. That makes the definitions critical. “Roof” may mean only the membrane, or it may include the deck and structural members.

Parking needs the same attention. The tenant usually handles sweeping, striping, sealing, and patching. Resurfacing and replacement of the sub-base are often negotiated.

The allocation can also be adjusted for how involved the landlord wants to be. Should the tenant use the landlord’s preferred contractors? Are there repairs above a dollar threshold that require the landlord’s approval? Should work on the roof be performed only by the landlord’s roofing contractor so the roof warranty is preserved?

At the far end is the bondable lease, also called an absolute triple net lease, a true triple net lease, or a “hell or high water” lease. The tenant bears the risk of casualty and condemnation in addition to the three nets. It must rebuild the premises after a casualty, even if insurance proceeds fall short, and it must continue paying rent after a condemnation. It has no right to terminate the lease or abate rent because of either event.

Before You Sign

Although the parties can contractually allocate these responsibilities, the triple net structure is industry and market specific. One question to ask in every negotiation is: Who performs the work? Generally, the party performing the work controls the scope, the timing, and the contractor, and has some degree of control over the cost. Scope matters most with capital replacements. A capital replacement should not be an upgrade. Read broadly, “if a capital replacement is necessary” could cover replacing an interconnecting stairway with an elevator, at a cost the paying party never anticipated.

Of course, a party’s negligence generally shifts responsibility for the resulting repairs.

Questions about how triple net is operating in a lease you are considering? Reach out to Varun Chari or another member of LP’s Real Estate Group.