NNN Leases on Residential Properties

[Ben Bakhshi]

Hi all,
Have any of you done this type of lease on a residential property?
I'd be happy to reduce cash-flow in exchange for a steady payment over a long time horizon of 5+ years.
It can also cut out management, both first hand management and 3rd party management.

Maybe I'm just fantasizing.

[Bill Gulley]

@Bryan H. HAPPY NEW YEAR!

Certainly Bryan, I was speaking to individuals as tenants with the NNN the first issue is maintenance, a tenant of residential property having to repair or replace a furnace for example can not write off that expense, they may not capitalize the cost or replacement. Under the IRS Code such improvements are to be depreciated, so what you have are depreciated amounts which were not an expense to the owner. Such expenses paid also are seen to give an individual tenant an equitable interest in that property arising from their making repairs and they may make such claims after tenancy (or any time).

Taxes paid by the individual or insurance are not an issue as such expenses are usually paid in monthly rents.

"Well, so are expected maintenance expenses, Bill" Yes, true, but the difference is the risk assumed by a tenant to pay more than "expected" expenses. The risk of the furnace going out is a risk of ownership not tenancy. This goes to the basic bundle of rights and responsibilities or ownership and those assigned by a residential lease, tenants have the right of possession and quiet enjoyment. These rights are to be conveyed for the payment of rents without any other financial requirement or assuming any risk or expense of ownership. These risks are assumed and remain with the owner as the owner retains the benefits of owning the real estate, tax benefits, appreciation along with the equities.

Commercial leases are different, mainly because the tenant has the opportunity to capitalize and expense direct payments for taxes, insurance and maintenance. Since a business can benefit from replacing that furnace as the leasehold interest the owner may transfer these risks. So it boils down to tax requirements and the ability of a tenant to receive a benefit for assuming additional risk.

In your example, if the lease is made to individuals then they should not be paying on a NNN basis. If you are leasing to an organization, a non-profit for example, as a business they may assume and benefit from the assumption of risks and expenses. The fact that the property is a SFD is irrelevant.

If these aspects are not covered in state law they will be in practice by the courts as they are anchored in tax law and accepted accounting principles applicable to business interests of the owner and tenant. :)