Triple net and expense recoveries
Also called NNN, Triple net, CAM recoveries, Expense reimbursements.
Under a triple net lease the tenant pays base rent plus its share of the property's taxes, insurance and common area maintenance. Expense recoveries are the mechanism that bills those costs back, normally as a pro rata share based on the tenant's proportion of the building's leasable area.
How it works
Lease structures sit on a spectrum. A full-service gross lease bundles everything into one rent, with the landlord carrying every operating cost. Modified gross sits in between, commonly with a base year or an expense stop. Triple net pushes taxes, insurance and common area maintenance to the tenant, so the landlord's income is closer to a net rent and the operating expense ratio is much lower. Absolute net goes further and hands over structure and roof as well.
The important mechanical detail is that recoveries are not a margin. Recovery income is offset by the expense it recovers, so a triple net property with $6.20 per square foot of recoverable expenses shows both the expense and roughly the matching income, and NOI moves only by the unrecovered portion. A model that adds recovery income without the corresponding expense creates income out of nothing.
What actually moves NOI is the leakage: vacant space has no tenant to bill, so the landlord absorbs the recoverable expenses on empty suites, and caps, exclusions, gross-up provisions and administrative fees all change the recoverable amount. Recovery ratios of 90 to 97 percent are common on a well-leased net property, and the gap is the landlord's real exposure.
Formula
Tenant recovery = pro rata share x recoverable expenses, adjusted for caps, exclusions and any administrative fee- Pro rata share = tenant leasable area / building leasable area, sometimes measured against occupied area instead
- An administrative fee, commonly 10 to 15 percent, is often added to the common area maintenance component only
- Vacant space produces no recovery, so the landlord absorbs recoverable expenses on empty suites
Worked example
Illustrative. 180,000 square foot building, 25,000 square foot tenant, recoverable expenses $6.20 per square foot of which $2.40 is common area maintenance, 15 percent administrative fee on that component. Building is 88 percent leased.
| Tenant pro rata share | 13.89% |
|---|---|
| Tenant recovery before the administrative fee | $155,000 |
| Administrative fee on the CAM component | $9,000 |
| Tenant total recovery | $164,000 |
| Recoverable expenses on the 12% vacant space | $133,920 |
| Landlord absorbs from vacancy | $133,920 |
The recovery itself is close to a pass-through. The number that changes NOI is the $133,920 the landlord eats on empty space, and it grows every time occupancy falls.
The common mistake
Assuming one hundred percent recovery on a partly leased building
Recoveries are billed to tenants, and vacant space has none. Modelling full recovery of taxes, insurance and common area maintenance on a building that is 88 percent leased overstates NOI by the recoverable expenses on the other 12 percent, which on this property is nearly $134,000 a year, or about $2.3 million of value at a 5.75 percent cap rate. Recoveries have to be modelled against occupied area and re-derived every time occupancy changes.
Related terms
- Expense stop and base yearIn a gross or modified gross lease, an expense stop is the level of operating expenses the landlord absorbs, with the tenant reimbursing everything above it. A base year stop sets that level equal to the actual operating expenses in the lease's first calendar year.
- Operating expense ratioThe operating expense ratio is total operating expenses divided by effective gross income. It is a fast sanity check on whether an expense budget is plausible for the asset type, the market and the way the property is run.
- Percentage rentPercentage rent is additional rent a retail tenant pays based on sales above a threshold called the breakpoint. It gives the landlord participation in a tenant's success while keeping base rent at a level the tenant can carry in a weak year.
- Lease rolloverLease rollover is what happens when a lease expires: the tenant renews, or leaves and the space sits empty until a new tenant is found and fitted out. Modelling it means applying a renewal probability, downtime, leasing capital and a new market rent to every expiring lease.
- Other incomeOther income is every dollar a property collects that is not rent for the space itself: utility reimbursements, parking, storage, pet rent, application and administrative fees, late fees, laundry, and amenity or trash charges. It is added to rent revenue on the way to effective gross income.
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