Triple nets on rise for commercial leases

Landlords can control the lease rates they charge for commercial properties, but one thing they can’t control is the triple nets.

And though commercial lease rates haven’t gone up significantly, triple nets have, meaning that while tenants are paying more for office, warehouse and retail space, their landlords aren’t generating more profits.

Triple nets, or NNN, refer to three types of expenses on a property above the base rent that include the tenant’s share of the property taxes (the largest portion), building insurance and common area maintenance, or CAM. CAM refers to the maintenance of the buildings’ common areas, paid pro-rata by the tenant, such as for snow removal, landscaping, and janitorial, water, sewer and trash services, or even things like advertising fees in the case of a shopping mall or large retail outlet.

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Triple nets can be the responsibility of the tenant through absolute net leases, or itemized as additional rent in a net lease or with the items built directly into the lease in a gross lease. The full-service gross lease has all expenses, including the utilities, as part of the lease. The type of lease varies by building type and landlord preference — an absolute net lease, for example, may be for an industrial or retail building and a full-service gross lease for an office building.

In the case of a gross lease, the landlord takes the risk in the variable of the expenses, said Gage Osthoff, a broker with Realtec Greeley and a board member with the Northern Colorado Commercial Association of Realtors. Landlords reduce their risk by adjusting triple net payments through an end-of-year reconciliation or accounting process to calculate whether actual triple net costs (and payments collected from tenants) align with the estimates that were charged starting at the beginning of the year, he said.

“While those property expenses don’t necessarily affect the landlord, they do in a roundabout way,” Osthoff said. “It helps to control the expenses to keep tenants happy and protect the bottom line.”

In the past five to nine years since the Great Recession, commercial lease rates in Northern Colorado have been lower and vacancy rates higher, giving tenants the advantage, until about the past one to two years when the opposite has occurred to the landlord’s advantage, said Mark Bradley, managing broker of Realtec Greeley. In the past four years, the cost of new construction also has been going up dramatically, he said.

“Supply and demand has caused land costs to go up pretty much across the whole market,” Bradley said. “We don’t see lot of new construction in most property types, so the supply isn’t getting out of hand. We anticipate vacancy rates will remain low and lease rates will remain fairly high.”

Josh Guernsey, managing partner of Waypoint Real Estate in Fort Collins, has seen construction costs, land costs and municipality fees significantly increase in the past five to 10 years and that landlords needed to raise their lease rates to support the higher costs.

“At the same time, we’re seeing an increase in triple net expenses,” Guernsey said. “It’s placing stress on tenants, because they’re seeing an increase in triple nets and property costs.”

Triple nets are rising, in part, from an increase in labor costs, Guernsey said. Labor costs for the CAMs, particularly in the trades and maintenance, have risen in the last two to three years, he said.

“It’s just a constrained labor market. Construction and the trades are seeing it, and where that shows up is in higher costs in the CAMs,” Guernsey said. “It’s just expensive to have work done right now.”

The constrained labor market and a low unemployment rate caused many vendors and suppliers to raise prices post-recession both in the triple nets and in new construction, said Keith Kanemoto, broker associate with Re/Max Traditions Inc. Commercial Division in Longmont.

“Post-recession, we have seen new buildings being constructed in Northern Colorado,” Kanemoto said. “However, due to increased material costs and labor costs, it has driven up the overall cost of building, which raises the asking rents for the developer due to increased construction costs.”

Also affecting the triple net expenses are mill levy increases, mill levy overrides and increases in the valuation of commercial properties, resulting in higher property taxes, Kanemoto said.

“The strong real estate market has raised the assessed values of commercial real estate, thus increasing the real property taxes that are passed on to the tenant as part of the NNN cost, or triple net,” Kanemoto said.

Commercial properties in Weld County, for instance, are seeing less of an increase on property taxes with support coming from the oil and gas industry, while Larimer and Boulder counties are seeing a more dramatic increase, Bradley said.

In Fort Collins, property taxes on commercial properties have increased 33 percent in the past five years and 16 percent in the past three years, Guernsey said, adding that such an increase is not sustainable in the long term.

“We’re in a cyclical industry,” Guernsey said. “We have signs that we’re at the top of the market, a high lease rate and high value in terms of the real estate cycle. Everything is cyclical, so costs will need to come down going into the future. In order to support new projects, lease rates will need to stay in a realm that is affordable for users.”

In the meantime, proposed projects are being delayed due to the high construction costs and rents not supporting them, and instead older properties are being purchased and renovated and repurposed to keep rents at a marketable level, Guernsey said.

“Triple nets are on the rise across the board, which is increasing the tenant’s overall facility costs,” said Scott Reichenberg, president and principal with The Colorado Group Inc. in Boulder. “Landlords are not making as much in these good times as one would think as triple net increases are overshadowing the rent increases. The base rental rates still increase, but the operating expenses for these buildings have shot up tremendously due to property tax increases during this last assessment period. … The only variable landlords can control or are forced to control is their base rate.”

In the commercial real estate market, base rents depending on the product type and location are trending upward, Reichenberg said. Because of the high demand for commercial property, the supply of new space will need to come from new construction, he said.

“These days, you can’t build it for cheaper than what you can buy existing products,” Reichenberg said. “The cost of the new construction correlates directly with the lease rates and the cost to build. Construction prices are very expensive these days, which translates to more expensive base lease rates. These rates from new construction are relatively higher than the existing product’s rate, which therefore allows the landlord to pull up the base lease rate on the existing property.”

The overall cost of commercial properties varies by geography and locale, as well as property type and function and the quality of the property, including whether the property is new or older, Osthoff said.

“It’s certainly just seeing where those limits are, what the triple net costs are both because of the property tax and the other taxes, seeing how much the tenant can afford to pay so they’re successful,” Osthoff said. “The biggest thing is the landlord wants the tenant to be successful.”