The use of triple net leases for logistics real estate and in sale-and-leaseback transactions

Elements of a triple net lease

Under a triple net lease agreement, the following three elements (in addition to the usual lessee obligations) are also at the tenant’s expense and risk: (1) costs for major maintenance and renovations, (2) insurance costs, and (3) property taxes.    

Single tenant and (tenant) specific modifications

This type of contract is ideally suited for leasing or renting out logistics real estate. After all, these are often properties leased to a single tenant, for whom the property is specifically designed and built by the developer.

During lease negotiations, agreements are often made regarding the technical systems a specific tenant requires (such as a material handling system) and which party will install them: the developer/landlord (whether or not as part of the leased property) or the tenant (as a turnkey package). If the tenant wishes to have this installed by the developer during the construction process, careful consideration must be given to the timing. As a landlord, you would prefer to avoid a situation where a tenant can already begin installing its installation package while the landlord’s/developer’s construction work is still in full swing. After all, different contractors and other auxiliary parties can get in each other’s way, which can cause delays and increases the risk of (hidden) defects.

However, if time is limited and the tenant—in order to meet a specific deadline for occupancy—must nevertheless begin installing their fixtures during the construction process, a sound contractual approach must be devised to ensure this proceeds smoothly . Failure to do so is asking for legally complex disputes (regarding handover, defects, and liability) at a later date.

Sale-and-leaseback

When a party needs a distribution center for its own business, it is common for that party to have it developed and built under its own management. Once the distribution center has been delivered to the party’s full satisfaction and put into use, it can still be sold (immediately or in the future) to an (institutional) investor. The owner then becomes the tenant through a “sale-and-leaseback” transaction. With the capital thus freed up from the property, the party can then make other investments. From a financial perspective, however, the party is still responsible for the rent and the costs arising from the triple net obligations.          

Such a “sale-and-leaseback” transaction, combined with a triple net lease agreement, can be attractive to (institutional) investors. Their primary interest lies in the certainty of receiving a stable rent, often combined with an expected increase in the property’s value. With a triple net lease, they do not have to actively manage the property’s maintenance (and often have no desire to do so). At least, as long as the tenant adheres to its obligations; otherwise, maintenance backlogs arise, and  this can erode the property’s value.  

A “sale-and-leaseback” transaction can also be attractive for a seller/landlord. After all, the tenant is the former owner of the property, who knows it better than anyone. As a result, such a tenant can often accurately estimate the costs of maintenance (and the other triple net elements) and how this can be carried out most efficiently.

The landlord need only check every few years to ensure the tenant is fulfilling their obligations. In practice, the maintenance level is often assessed by an independent party at the start of the lease based on NEN 2767, and the condition scores are recorded. The tenant is then obligated to maintain the property at those condition scores, and the landlord may verify this from time to time with a new assessment. Agreeing in advance on a long-term maintenance plan and updating it over the years can also be part of the arrangements.

Term lengths and investments at the end of the lease

Triple net lease agreements often involve lease terms spanning decades, ranging from 10 to 30 years or even longer. This is advantageous for the landlord, as it reduces the risk of the property standing vacant. For contracts with a shorter term, triple net is somewhat less suitable. For example, in a three-year lease, it makes less sense for a tenant to also bear the cost of upgrading technical systems during that period. Especially if the upgrade is due when only a small portion of the lease term remains and the lease is terminated, causing the system’s lifespan to significantly exceed the lease term. After all, the tenant would then have to make a substantial investment in such a system, while the landlord and/or a new tenant would be the ones to reap the benefits. Of course, customized arrangements can be made regarding this, and triple net can also be used for shorter lease terms. As long as the parties are fully aware of the obligations assumed by the tenant.  

If an (institutional) investor succeeds in finding a tenant who is a good tenant (even in the long term) and thus offers consistently stable rental income, a logistics property with a triple net lease agreement can be very attractive. And in the event of a sale by a developer to an (institutional) investor, such a stable tenant can significantly increase the purchase price.

Contract formation

When a landlord and tenant – prior to negotiating the lease agreement – make general arrangements in a letter of intent or similar document, it is important to realize that the term “triple net” is not defined anywhere in Dutch law and originates from abroad. It is clear which three elements comprise it, but the exact scope of those elements can sometimes be subject to debate.

This is particularly the case with regard to major maintenance and renovation. For example, work mandated by the government is not necessarily automatically included. Consider, for instance, work related to energy-saving measures, any (future) energy label requirements, and asbestos-free roofs. With regard to such matters, the legislature imposes certain obligations on the property owner and/or the tenant, and this will only increase in the future – especially when it comes to the energy transition.

Such work could be regarded as renovation work (rather than maintenance work), involving an improvement to the leased property. This is distinct from maintenance carried out to preserve the leased property through repair, replacement, or renewal. Parties wishing to avoid disputes regarding the exact scope of the triple net arrangement as much as possible during the negotiation of the lease agreement itself, would therefore be well advised to describe in greater detail, already in the letter of intent, what they believe falls precisely under the intended triple net situation.

The ROZ model for 230a space mentioned earlier was not written for a triple net situation. In practice, however, that model is often used as a basis, with one or more specific clauses added containing arrangements (deviating from the general provisions) regarding the three triple net elements. Consider, for example, modified arrangements regarding when the landlord’s consent is required for alterations or modifications to the leased property. If the tenant must always first seek the landlord’s permission, the tenant’s autonomy is reduced, and the landlord must still be involved in the property more frequently.

Finally

Precisely because logistics real estate often involves (triple net) lease agreements spanning decades, it is essential to carefully consider these agreements from a legal perspective. This can save costs, but a well-drafted agreement also helps avoiding unpleasant disputes with your landlord or tenant down the line. This is all the more important when the parties will remain bound to each other for many years to come. If both parties know exactly what is expected of them, there is a greater chance that this will be carried out properly and on time, and that the value of the property will be maintained.  

Our Construction and Real Estate Team has extensive experience in drafting and negotiating (triple net) lease agreements for logistics real estate, among other things. We are happy to work with you, preferably as early as the phase of a potential letter of intent.