Net leases are popular for commercial real estate investors due to their stable income streams and relatively hands-off management structure. However, understanding the different types of net leases and the intricacies of buying leaseholds can help investors maximize returns and mitigate risks. This guide will explore the types of net leases — single, double, and triple net — and delve into the benefits and challenges of buying leaseholds versus traditional fee simple ownership.

Types of net leases

Single Net Lease (N)

In a single net lease, the tenant is responsible for paying rent and property taxes, while the landlord handles other operating expenses such as insurance and maintenance. While this structure offers tenants some financial predictability, landlords remain responsible for most property costs. Single net leases are less common in commercial real estate compared to their double and triple net counterparts.

Pros:

Lower costs for tenants compared to more comprehensive net leases.

Landlords maintain control over the property's maintenance and upkeep, which can protect long-term value.

Cons:

Higher financial responsibility for landlords, who still manage property expenses like insurance and maintenance.

Double Net Lease (NN)

A double net lease shifts more responsibilities to the tenant, who pays both property taxes and insurance premiums, while the landlord remains responsible for structural maintenance. This type of lease is more common in commercial real estate, especially for smaller retail or office properties.

Pros:

Reduced financial burden on landlords compared to single net leases, as tenants share the responsibility for taxes and insurance.

Tenants have more control over managing operational expenses.

Cons:

Landlords still handle structural repairs, which can lead to unpredictable costs over time.
 
Triple Net Lease (NNN)

A triple net lease, the most common type for commercial real estate, shifts nearly all financial responsibilities to the tenant. Tenants pay property taxes, insurance, and maintenance, while landlords receive a stable, predictable income stream without having to manage day-to-day expenses.

Pros:

Landlords enjoy minimal financial responsibility and stable, passive income.

Tenants have complete control over managing property expenses, leading to potential cost efficiencies.

Cons:

Properties under triple net leases tend to have lower cap rates than other leases, potentially lowering returns.

Tenants may be less incentivized to invest in long-term property improvements, which could impact property value.

Fee simple vs. ground lease vs. leasehold ownership

Ground Lease Ownership

A ground lease involves one party's ownership of the land while a different entity owns the building or improvements on the land. These leases tend to be long-term, lasting 50 years or more, and are common in high-demand areas with premium locations, such as bank branches, corporate offices, or big retail chains.

Pros:

Lower acquisition costs for investors since only the land is purchased.

Consistent, long-term income from prime real estate locations without the responsibility of managing a building.

Cons:

Investors cannot depreciate the property since they do not own the building.

Lack of control over the building and its use, which can be limiting if the property requires significant improvements or redevelopment.

Why Investors Buy Ground Lease Ownership

Investors are drawn to ground lease ownership because it provides stable, long-term income with minimal management responsibilities. Since the tenant typically owns and manages the building, the investor’s primary concern is collecting ground rent. Ground leases tend to be located in prime real estate markets, offering excellent locations without the high upfront costs of purchasing both the land and the building. Additionally, ground leases can offer predictable income over long periods (often 50+ years), making them ideal for investors seeking steady returns without the operational burdens of owning the improvements.
Ground leases also appeal to institutional investors and large corporations due to the ability to generate cash flow from high-demand areas while mitigating risks like property maintenance or redevelopment. Although investors do not own the building, the land’s appreciation over time can provide a solid return on investment. This structure is particularly beneficial for investors who want exposure to premium locations at a lower price point than fee simple ownership.
Fee Simple Ownership

Fee simple ownership is the most straightforward and complete form of real estate ownership, where the investor owns both the land and the building. This type of ownership offers full control over the property, allowing for the greatest flexibility in terms of development, management, and tax benefits.

Pros:

Full control over the land and building, enabling investors to make improvements, redevelop, or sell without restrictions.

Ability to depreciate both the land and the building, providing significant tax benefits.

Cons:

Higher upfront costs compared to leasehold or ground lease arrangements.

Greater responsibility for managing both the land and building, which can increase operational complexities.

Why Investors Buy Fee Simple Ownership

Fee simple ownership is attractive to investors who seek complete control over both the land and the building. This form of ownership allows for greater flexibility in property management, redevelopment, and long-term investment strategies. Investors can make improvements, reposition the property, or redevelop it entirely without restrictions imposed by a lease. Additionally, fee simple ownership comes with the advantage of being able to depreciate both the land and the building, providing significant tax benefits.

For those looking to maximize control and long-term value, fee simple ownership offers the opportunity to capture the full appreciation of the property over time. Investors may also prefer fee simple ownership because it provides the option to refinance or sell the property at any point, giving them the freedom to capitalize on market conditions. The ability to generate income while maintaining full decision-making power makes fee simple ownership the most versatile and valuable option for many real estate investors.

Leasehold Ownership

In a leasehold arrangement, an investor owns the building but not the land. The land is leased from the landowner, often for extended periods (e.g., 50 years), allowing the building owner to benefit from the property's income without the significant cost of owning the land.

Pros:

Leaseholds often provide higher cap rates than fee simple properties, as the initial investment is lower due to not purchasing the land.

Lower acquisition costs make leaseholds attractive for investors seeking high returns in prime locations.

Cons:

In many cases, investors cannot depreciate the building, reducing the tax benefits available compared to fee simple ownership.

Lease terms can expire, leading to uncertainties about the future of the building and tenant relationships.

Why Investors Buy Leaseholds

Investors may choose to buy leaseholds, particularly in prime markets with extremely high land values. Leaseholds can offer higher cap rates and better cash-on-cash returns than fee simple ownership, making them appealing to investors seeking short- to medium-term gains. For example, an investor might purchase the leasehold interest in a CVS store where the building is owned, but the land is leased. These properties can offer returns in the 7-8% range due to their lower initial costs.

Leaseholds are often attractive for tenants with long-term stability, such as national chains or banks, where the risk of the building being torn down or redeveloped is low. Investors who understand local zoning rules, tenant stability, and market trends can successfully capitalize on leasehold opportunities.

Key considerations when buying leaseholds

Financing and Cap Rates

One of the main advantages of leaseholds is the potential for higher cap rates compared to fee simple ownership. Leasehold properties typically offer cap rates in the 7-8% range, making them appealing for investors seeking steady income streams. Additionally, these properties can often be financed despite lacking land ownership, especially when the leasehold term is long enough (e.g., 50 years).

Risk Management in Leasehold Investments

While leaseholds offer attractive cap rates, they also come with risks. Lease terms may expire, leaving the investor without ownership of the land or the ability to redevelop the property. To mitigate these risks, investors must carefully evaluate the lease terms, tenant stability, and local zoning regulations. Additionally, it's crucial to understand the potential for redevelopment or changes in land use, which could impact the long-term value of the leasehold.

Building wealth through strategic ownership choices

Investing in net leases, ground leases, fee simple ownership, or leaseholds each offers distinct paths to stable returns and long-term success. Ground leases provide steady income from premium locations with minimal management, while fee simple ownership delivers full control and flexibility. Leasehold ownership combines lower acquisition costs with attractive cap rates, making it a strong option in the right markets.

Choosing the right investment depends on your goals and understanding of market dynamics. With the proper strategy, these diverse ownership options can help you build a portfolio designed for growth and financial security.