Triple-Net (NNN) Lease 1031 Exchanges: What It Is and Why Investors Favor NNN Properties

Retirees can generate passive income and maintain tax deferral by completing a triple-net lease 1031 exchange into a property that requires less active management.

JTC has helped property owners perform IRC Section 1031 like-kind exchanges with many different property types, including (but not limited to) single-family and multi-unit residential, office, retail, warehouse, farmland, mining, oil & gas, and fractional ownership of commercial portfolios through Delaware Statutory Trusts (DSTs). Different investors have different needs, so it’s important to understand the advantages of the various types of properties and ownership structures.

A type of lease structure that causes confusion for some is the triple-net (NNN) lease, which involves greater financial responsibility on the part of the tenant. For some property owners, an NNN lease can be ideal for creating passive income due to its hands-off nature. Let’s go over the basics of this type of lease and why it can be attractive for taxpayers looking to perform 1031 exchanges as they retire.

What is a triple-net (NNN) lease?

A typical lease will dictate what duties are the renter’s responsibility and what are the owner’s. For example, in a standard apartment lease, things like electricity, water, and trash are often the renter’s responsibility, while property taxes, insurance premiums, and repairs & maintenance are all the responsibility of the landlord.

But there are also “Net leases,” which assign more of these costs to the tenant. They are generally used in commercial real estate situations, often when there is a single tenant. Net leases are divided into single, double, and triple-net varieties:

Our focus is the triple-net lease, which is where the tenant must pay 100% of the property taxes, insurance premiums, and maintenance costs. Rent is usually lower with NNN because of the increased cost due to taxes and insurance premiums, which are often paid to the landlord along with rent payments.

There is also a subset of triple-net known as a bondable net lease. This means the tenant cannot break the lease before its expiration date. A bondable net lease provides extra security for landlords, as the lack of day-to-day oversight means the tenant must be trusted to perform maintenance on their own. If maintenance costs go up, a tenant may no longer like the lease terms, but a bondable net lease ensures they can’t terminate the lease.

Advantages of a NNN leases for 1031 exchange investors

What’s most attractive for property owners (especially those not interested in being hands-on landlords) is that there’s zero maintenance involvement. That includes everything from the parking lot and roof to plumbing, electrical, and HVAC. None of that is the landlord’s responsibility under a triple-net lease, making NNN leases more of a passive investment.

Another advantage is the lease terms, which are generally longer than standard leases. This means you don’t have to repeatedly find new tenants every couple of years and worry about vetting the financials of a new group of renters. And since most triple-net leases are single-tenant leases, property owners will only have to deal with one renter – a big change for those used to multifamily apartment buildings.

Common triple-net lease tenants, and why they choose NNN

Because of the long lease terms and added responsibility, triple-net tenants are usually established, creditworthy businesses. Think chain restaurants, retail stores, banks, etc. While there are some industrial and office triple-net locations, you’re most likely going to be dealing with retail.

Part of the decision for the renter comes down to the building itself: if the tenant thinks maintenance costs will be low, then they’re getting a bargain on rent. However, if they’re wrong about that, the added maintenance costs may hinder the ultimate success of the business.

Tenants also may be gambling when it comes to the number of tenants involved: if you have a single-tenant triple-net lease, the additional costs are absorbed by one lessee. But consider a shopping mall: if all the units are occupied, each renter only has to pay a small fraction of the property taxes; if half the stores are empty, each tenant will have to pay a greater share of property taxes.

Large companies have an established way of doing business, and specific standards. They know how they want the building to look, they’ve got their own repair people, and they don’t want to have to worry about moving to a new location every couple of years. A triple-net lease allows them to secure their space for a long period of time without having to rely on the landlord to perform tasks they’d rather manage themselves. (Imagine you run a retail chain with 250 stores. Would you want to have to keep track of 250 landlords to manage day-to-day requests at each and every location?)

Lease terms, inflation and rent increases

Most triple-net leases have a primary term of 10-20 years, often with multiple five-year renewal options and built-in rent increases at five-year intervals. With rent increases built into the lease terms, there’s no need to worry about renegotiating rent or unexpected vacancies, as everything is predetermined.

Selling a triple-net property: right of first refusal

Some triple-net leases give the tenant a right of first refusal. That means that if the tenant wants to purchase the property, they are guaranteed the first opportunity to do so. Some leases give them the option to match any offer found on the open market, while others may dictate the exact price at which the property can be purchased.

Because you may be dealing with a large company that can afford to buy property at a competitive price, these addendums to your lease matter. Understanding the tenant’s right of first refusal from the beginning will help you maximize your potential gains on the eventual sale. Knowing your purchaser ahead of time can make executing a like-kind 1031 exchange easier, as you’ll have time to engage a Qualified Intermediary (“QI”) and find a replacement property.

Is a triple-net lease right for your 1031 exchange?

The most attractive element of a triple-net lease is that it offers passive income. This makes it great for property owners who are reaching retirement age. Those who used to own management-intensive properties such as apartment buildings or office complexes can perform a 1031 exchange into an NNN property where they no longer have to worry about day-to-day management and have guaranteed tenants that will be there long-term.

Another type of real estate investment that generates passive income is the Delaware Statutory Trust (“DST”). Investors entering retirement frequently exchange into DSTs because they can provide steady income during retirement and have advantages for estate planning. To learn more about the choice between a NNN lease and a DST, read our blog on the subject.

Work with an experienced 1031 Qualified Intermediary (QI)

If your plan is to hold this new property for the rest of your life, you can enjoy receiving income with less work than with traditional rental properties. Triple-net leases can qualify for a 1031 exchange, but the same safe harbor rules apply: you’ll need to identify the replacement property within 45 days and work with a Qualified Intermediary.

A QI is the third party that holds funds during your 1031 exchange so you don’t take active or constructive receipt. While there aren’t a lot of legal requirements for becoming a QI, with your tax deferral status (and potentially our retirement income and legacy for your kids) in the balance, this isn’t the time to work with an inexperienced novice.

JTC’s 1031 exchange team has worked as QI for Fortune 500 companies and DSTs as well as everyday investors executing their first exchanges. We offer the same secure solutions for single-property owners that we do to large corporations, including our 24/7 online portal where you can view exchange status at any time, from anywhere. No matter what kind of replacement property you chose, work with an experienced QI that can handle your unique situation.

Learn more about JTC’s 1031 services