Net Leases

In essence, a net lease is simply a form of land ownership in which the owner of a strategically placed parcel of property (for example, at a busy intersection) leases rather than sells it to a user. A net lease is one in which the user – the tenant – agrees to pay all costs (including real estate taxes), carry insurance for the benefit of the land owner, make all repairs and replacements to any construction that he or she builds and operates, and keep the property in good condition. Typical deals that use net leases are those involving office buildings, gas stations, and fast food restaurants.

The renter (or lessee) usually plans his or her own construction, and so will insist on a long-term lease – anywhere from twenty years and up – in order to tie up the land and recover building costs, as well as earn a return on the investment. A well-known example of a net lease situation is the New York City's Empire State Building. It was constructed on a long-term land lease that has approximately sixty years left to run. Technically, the owners of the building are tenants of the land and pay ground rent. Most long-term net leases provide for the following:

• Rent adjustments based upon cost-of-living adjustments (or COLA).
• Fixed increases in rent over time.
• A percentage of sales above a certain "strike point"; in other words, the tenant's sales level at which percentage rent increases begin.
• Any combination of these factors.

At the end of the lease term, most leases require the return of the property to the landowner in its original condition. At that point, one of three things will happen:

• The lease will be renewed.
• The landlord (or lessor) will insist upon demolition and removal of any construction on the land done by the tenant during the term of the lease, thereby preparing the land for other uses or new tenants.
• The landlord will agree to accept the return of the leased land as is; in other words, including any construction that was done during the lease term. As previously stated, because most net leases require that the land be returned to its original condition, as-is deals are frequently made. This saves the tenant the costs of demolition and subsequent restoration, and also enables the landlord to rent the building or convert it for another use.

Net leases are very easy to manage. The landowner simply collects the rent, with no further responsibility to the building or business that's renting the land. Additionally, net leases can be highly leveraged, especially if the tenant has a triple-A credit rating. And over time, net lease locations generally become more valuable. But even if the property's value doesn't increase, the long-term lease rent from the tenant will continue to provide income over the life of the contract; and at the end of the lease, the land, building and all of the improvements will belong to the landowner. The lease can be renewed or the land and improvements can be rented to another tenant. Net long-term leases, therefore, enable investors to enjoy the benefits of real property ownership and leverage with virtually none of the customary management responsibilities.