Triple Net Leases – Property Tax Reimbursement
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I few posts ago I promised that I would go into greater detail regarding aspects of a commercial lease that the prospective buyer needs to examine carefully.
Without the underlying leases the property is worth replacement costs and comps of similar vacant property. Given that the cash flow of the leases in place is what you paying for, it’s a good idea to make sure that you’re getting what you think you are. It’s also an excellent idea that the in place tenants understand what they signed. Do I have stories of things gone wrong – you betcha!
One of the factors that concern me most on a new build, especially a multi tenant new build, is property taxes. I’m not nearly as concerned with large national credit tenants in single tenant properties. Those folks know how it works. What I’m much more concerned with is a new build, multiple tenant property with local tenants on triple net leases. Maybe this is the first or second lease they’ve done during the life of their business. And what if that new build was on unimproved land and taxes reset on a triennial basis or when the property sells? You already know where I’m going with this? Actually, all of this is pretty common set of circumstances.
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The developer buys the land and builds a three tenant medical building for example. The developer, and part owner, the listing agent, builds the improvements and negotiates leases. The leases detail pretty well that the tenants are responsible for actual property taxes, even as a result of a sale. Tenants (Doctors) obviously ask what their triple net expenses will be. Problem is that the then current NNN expenses as far as property taxes are concerned are based on the unimproved land. In this case the land was assessed at $135,000. Being a fairly typical doctor, he never read the leases and signed with the notary with wink wink, nod nod from the developer and listing agent that taxes “wouldn’t change much”. He also signed a lease addendum for additional space with the same language concerning taxes, and again signed it without reading it.
About six months later the property was put on the market and here comes the buyer’s agent with buyer in tow having no way to know any of this history. First thing the buyer’s agent does is ask for all the leases, addendums, etc., to review carefully before an offer was even made. Offer was made and accepted on the $2.27mil property and due diligence begun. The buyer’s agent and attorney asked the seller to have a lease clarification regarding CAM and reimbursable expenses to be signed by the tenant. The bank also asked for a NDA and tenant estoppel and so did the buyer’s attorney. That’s a total of five documents and the doctor didn’t read any of them nor have an attorney review them ignoring advice to do so.
The deal closed, taxes not only reset, but did retroactively to the beginning of the year of the closing, and the doctor’s reimbursable expenses increased by about $3,000 per month for taxes. Guess what happened?
The new owner was in no way at fault or had any knowledge of what transpired before the building was built and during the lease negotiations. Does this give you chills? It should when you think about it.
In summary, be very very careful with inexperienced local tenants in a multi tenant, new build with triple net leases. True this sounds like a very specific set of circumstances, but it represents a substantial percentage of the multi tenant market.
