A single-tenant net lease, or STNL, is a type of lease agreement in which an entire commercial property is leased to just one tenant on a triple net basis. Like with any real estate investment, owning an STNL property has its pros and cons. With that in mind, here's a quick overview of how a single-tenant net lease works, why they can be good investments, and the potential drawbacks you should be aware of.
What is a single-tenant net lease?
Under the terms of a single-tenant net lease, an entire commercial building is leased to a single tenant. This lease type can be used with any commercial real estate such as healthcare, office, industrial and more, but it is most often seen in retail properties -- particularly drug stores, restaurants, gas stations, and other types that occupy standalone buildings.
An STNL is also known as a triple net lease, or NNN lease. This means that the tenant is responsible for three categories of property expenses:
- Property taxes.
- Building insurance.
- Most maintenance costs.
This is in contrast to a gross lease, under which these expenses are the responsibility of the landlord.
Single-tenant net leases are generally signed with long initial lease terms -- 10 to 20 years is common -- and with annual rent increases, or escalators, built in.
Advantages of a single-tenant net lease for investors
There are some big advantages to investing in properties occupied by a single tenant on a net lease. Just to name a few:
Not only does a single-tenant net lease create a steady income stream for a decade or more, but it also makes for very predictable cash flow as compared with, say, owning a residential rental property. Specifically, most of the variable costs landlords often have to deal with (taxes, insurance, and maintenance) become the responsibility of the tenant.
You won't have to worry about getting your tenant to agree to annual rent increases with an STNL. Typically, rent increases of 1% to 2% per year are built into these leases, which gives you an income stream that grows over time.
If you invest in an apartment building or shopping center, you'll need to find a tenant for every unit -- and keep them there -- if you want to achieve 100% occupancy. With a single-tenant net lease, you simply need to put one tenant in place and enjoy a decade or more of full occupancy.
Potential drawbacks of a single-tenant net lease for investors
Of course, there's no such thing as the perfect investment property, and single-tenant net leases are no exception. Here are a couple of major drawbacks you should consider before investing:
While you're more likely to have 100% occupancy with a one-tenant property, the other side of the equation is that your rental income is fully dependent on just one business. If your tenant vacates the property due to the end of a lease or a bankruptcy, your rental income immediately drops to zero.
On the other hand, if you own a building with 10 apartments and one tenant leaves, you still make 90% of the rental income. This is why with a single-tenant net lease property, it's extremely important to choose a high-quality tenant that is highly unlikely to leave.
Net leases typically have a 1% to 2% annual rent increase built in. This is great for predictability, which is why it's also listed as an advantage, but it can actually be a drawback if market rent rises faster.
For example, if the market rental rate for retail properties in your area rises by 5% one year, but your tenant's lease only includes a 1% increase, you'll find yourself collecting below-market rent.
An alternative to buying just one STNL property
Without question, the biggest drawback to investing in an STNL property is that you're entirely dependent on just one tenant.
One way to get around this is to invest in a real estate investment trust, or REIT, that specializes in single-tenant net-leased real estate instead of buying one property yourself. Realty Income Corporation (NYSE: O) is a good example, and one that I own in my portfolio. With more than 5,000 properties in its portfolio, it gives you the benefits of STNL real estate -- predictable, growing income -- but without the reliance on a single tenant for your investment success.
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