Not investment advice. Educational reading. See Disclaimer.
L.10 · INTERMEDIATE · 3 MIN
NNN vs Gross Leases (and Modified Gross)
The lease type buried in a property pro forma changes the entire risk profile of the investment. A triple-net lease with an investment-grade tenant on a long term is effectively a corporate bond; a short gross lease in a tertiary market is a much riskier asset with completely different cash flow dynamics. Two physically-identical buildings can trade at meaningfully different cap rates entirely because of differences in lease structure, tenant credit, and term remaining. Reading the lease is as important as reading the building.
The three lease types describe who pays the operating expenses. Triple-net (NNN) — tenant pays property taxes, insurance, and maintenance on top of base rent. Gross — landlord pays all operating expenses out of the gross rent collected. Modified gross — some categories pass through to tenant, others stay with landlord (varies by lease).
§ 02
Lease type
Who pays opex
Risk shift
Triple-Net (NNN)
Tenant pays taxes, insurance, maintenance
Maximum risk shift to tenant; landlord cash flow closest to bond coupon
Modified Gross
Negotiated split — typically tenant pays taxes/insurance, landlord pays maintenance
Partial risk shift; landlord absorbs structural maintenance and capex
Gross / Full-Service
Landlord pays all operating expenses out of rent collected
Landlord absorbs all opex inflation; tenant pays only base rent
§ 03
A long-dated NNN lease with an investment-grade tenant is functionally a corporate bond wrapped around a building. The cap rate on such an asset is best read as a credit spread over Treasuries — most of the return comes from the contractual rent stream, not from the underlying real estate. When that lease rolls, the asset transitions from a bond-like to an equity-like profile.
§ 04
The single most important number on any lease beyond term and rent is the weighted average lease term (WALT). A portfolio with a 12-year WALT and investment-grade tenants is materially safer than one with a 3-year WALT and small-business tenants, even if both portfolios show the same headline cap rate. REIT investors should always look up the WALT and tenant-credit profile before trusting a stated cap rate — the headline number alone hides too much of the actual risk.
§ 05
Pull a net-lease REIT 10-K (Realty Income, W. P. Carey, and STORE Capital are good examples). Find the disclosure of weighted average lease term and the tenant credit-rating distribution. Compare it to a gross-lease office REIT in the same filing season. The differences in WALT and tenant credit are typically much larger than the differences in headline cap rate — and they explain the cap rate spread between the two REIT subcategories.
§ 06
A net-lease REIT trades at a 5.5 percent dividend yield with a portfolio WALT of 11 years, weighted-average tenant credit BBB, and 100 percent NNN leases. The 10-year Treasury yields 4.5 percent. What is the most useful frame for evaluating this REIT?
Five questions · AI feedback
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Sit with the ideas.
An investor compares two single-tenant office buildings — Property A has a 15-year NNN lease with an investment-grade tenant at a 6 percent cap rate; Property B has a 5-year gross lease with a similar-credit tenant at a 7 percent cap rate. The two buildings are physically comparable. Why is the apparent yield premium on Property B not necessarily the better investment?
