Triple Net Lease - A Commercial Property Inspector's Perspective

[Martin Potokar]

Introduction

While Triple Net Leases continue to gain popularity over the years in more ways than one, especially when it comes to placing responsibility for the cost of maintenance and repairs on the tenant in addition to property taxes and building insurance in exchange for a lower rent compared to a standard lease, the question still remains as to whether or not a triple net lease is really the Panacea it claims to be for commercial property real estate owners and investors alike? In reality, based upon what I have witnessed over the past 30 plus years in conducting property condition assessments (PCAs) for commercial property regardless of age/type, I would have to answer 'No' primarily because experience has shown that not unlike those that rent residential property, the majority of tenants leasing commercial property are nine times out of ten not going to take care of the property as if it were their own in which event they will normally adopt a reactive rather than a proactive approach to save money (or so they think) when it comes to maintenance and repair needs. In reality, given a number of cases I've personally witnessed, a maintenance repair need may often go undetected as well as unaddressed if and when the lessee truly believes doing little to nothing will in no way disrupt the daily operations of the business. What's least understood is that while the building tenant or upper corporate management located elsewhere may sincerely believe they're making the right choice in the best interest of the company to save money, in most cases, the end result leaves much to be desired whereby the tenant may actually be unaware of their having to pay more money in postponing the inevitable making an existing condition much worse than it is as time goes on. Unfortunately, this in turn can also have other adverse ramifications that may end up affecting the pocketbook of the landlord due to the tenant's ignorance and negligence or seemingly lackadaisical attitude in maintaining the property according to the terms of the lease.

Case in Point

To prove a point, my company recently provided inspection services for a couple of commercial properties owned by a real estate investor who presently leases each property to a different franchise business, one of which represents a chain of successful retail store outlets (that doesn't need to advertise) and another that represents a successful 24/7 physical fitness exercise facility that often advertises on television during normal viewing hours. Interestingly, the two things these franchises have in common is that unlike most newly formed young brick and mortar businesses, they are both well established and recognized business entities each with an excellent track record whereby the landlord understandably doesn't have to worry about their paying the rent on time much less their going out of business overnight. The second thing they seem to have in common is that maintenance and repair needs relative to the building do not appear to be high on the priority list as long as they don't interfere with their place of business. For example, in conducting a high level due diligent assessment of package rooftop units at each location, we were altogether surprised by the deficiencies and deferred maintenance encountered during our assessment of the rooftop units given dirty air filters, worn fan belts, rusty and plugged condensate drain pan openings accompanied by condensate backup leaks down into the structure below mistaken for a roof leak by the building occupants inside, etc. In fact, upper corporate personnel, who happen to manage one of the leased properties from a remote location, apparently had a so called brainstorm that required setting two indoor thermostats to 65 degrees and 75 degrees during the hot summer months to save money. Unfortunately, little did they realize that setting the temperature of both thermostats in this manner ended up placing the burden of cooling on one package rooftop unit which was never intended by design to cool much less heat a building of this size by itself. Needless to say, this caused the rooftop unit to run continuously in a futile attempt to maintain much less lower the indoor air temperature to its thermostat setting especially on extremely hot days. What's probably least understood by the average lay person, allowing a package rooftop unit to operate in this fashion merely serves to shorten its life cycle in addition to costing more money to operate since the unit is consuming more gas and electricity in attempting to heat and cool the building on its own. And let's not forget that the cost to replace a package rooftop unit with a 5-ton capacity or more isn't exactly a cheap proposition and one that could easily end up costing a landlord anywhere from $1,200 to $1,500 a ton which equates to $6,000 to $7,500 for a 5-ton package rooftop unit. And believe it or not, we actually found a package rooftop unit with its service access panel totally removed leaving the package unit open to the element. While we could continue to provide more examples, hopefully you get the point.

The Solution

At first we believed that the resolve for maintaining package rooftop units or any mechanical heating and cooling equipment for that matter was to simply require a tenant to secure a service maintenance contract agreement with a bonafied, licensed mechanical heating & cooling contractor in order to mitigate the cost of repairs/replacement. However, we soon realized that asking a tenant to incur additional costs without offering anything in return such as a further reduction in rent was essentially a poor one sided solution as opposed to being a win win situation for both sides. Moreover, we also realized that if the tenant were to accept such an arrangement, there still needed to be a system of checks and balances in place to ensure that the tenant and mechanical contractor were initially diligent and continued to remain so in maintaining the package rooftop units over the term of the lease. The solution we eventually came up with deemed equitable to both parties was to have the landlord or tenant secure a service maintenance contract agreement with a qualified, licensed mechanical contractor. However, and as already mentioned, if a landlord decided to put the onus on the tenant to secure a service maintenance contract agreement, there needed to be a reduction in rent or some other strong incentive in the lease agreement in order to make this a worthwhile arrangement for both sides. Last but not least, regardless of who ended up taking the lead in securing a service maintenance contract agreement, the checks and balances system referred to earlier herein still needed to be implemented in which event the package rooftop units could be made subject to an annual due diligent assessment performed by a qualified, professional outside third party hired by the landlord to further ensure that the package rooftop units were being maintained according to the terms of the lease, a win win situation for both sides on all counts.