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Is A Triple Net Lease A Good Idea?

Is A Triple Net Lease A Good Idea?

For many years, triple-net leases have been popular in sale-and-leaseback arrangements. The tenant essentially assumes obligations that typically fall to the landlord and pays a lower rent in return. However, at the end of such agreements, disputes about alleged maintenance deficits and correspondingly demanded additional payments by the tenant have recently become more frequent.

It is not uncommon for landlords to be undone by the incomplete provisions of the underlying contracts, resulting in unsatisfactory solutions and, consequently, considerable costs before a new lease. So, is a triple net lease a good idea?

“Triple-net contracts,” which are not uncommon in the commercial sector, in particular, deviate from this division of responsibilities and largely oblige the tenant to maintain the leased property. This type of contract was popular in the 2000s, particularly in sale-and-leaseback constellations. However, these leases are now gradually expiring and give rise to discussion.

Often, High Maintenance Arrears Are Found At The End Of The Lease Agreement

At the end of the lease term, the landlord regularly commissions an expert engineering firm to assess the current condition of the property and-where present or identifiable-to evaluate omitted maintenance. Such appraisals regularly identify significant deficits, which the landlord then demands compensation from the tenant.

Depending on the property, the type of use, and the lease length, it is not uncommon for claims to run into the millions. The landlord then regularly refers to the relevant contractual clauses and the “spirit of the contract,” according to which the tenant should assume the role of landlord to a considerable extent and thus also bear complete responsibility for maintaining the property.

In this context, the landlord often regards technical expertise as a neutral expert opinion, leading to high expectations about the realization of the established claims.

On the other hand, the tenant is often convinced that everything necessary has been done during the rental period. The willingness to remedy or financially compensate for the identified deficits at the end of the lease is thus extremely low, let alone that precautionary provisions have been set aside for this purpose.

Regardless of whether or not triple-net contracts can be effectively agreed upon at all, many lease parties frequently discover that the concretization of the maintenance obligation in the contracts is not clear enough. And that the technical due diligence performed during the purchase process also did not adequately address this issue.

For example, the contracts frequently stipulate that you have to maintain the property’s condition. You also need to comply with the generally accepted rules of technology associated with the operation of the property and perform building maintenance under the requirements of public law. Something similar is how the tenant’s owed scope of performance during the lease term is typically described in abstract-general terms.

Extreme Positions Make Compromise Difficult

Thus, at the beginning of the exchange on these issues, two extreme positions (no compensation claim vs. claim in the millions) regularly oppose each other, and working out the relevant fundamentals is considered worthwhile in any case.

In this context, tenancy law meets facility management law. It happens because facility management law experts can provide the appropriate technical expertise. Only they are in a position to concretize the owed scope of services.

Only those who are very well versed in the technical regulations, correctly classify the demands, and at the same time work together will be able to determine which measures do not fall within the tenant’s scope of performance.

Usually, Bad Cards For The Landlord

From the experience of recent disputes surrounding the concretization of obligations arising from triple-net constellations at the end of the contract, a clear trend to the detriment of landlords can be derived. It is essentially due to two decisive aspects.

On the one hand, it is impossible to know the property’s condition in sufficient detail at the beginning of the lease term. In this respect, technical due diligence reports are usually too superficial and often only focus on so-called “dealbreakers” or the purely economic assessment of the condition. On the other hand, in very few transactions, the parties are willing to spend the necessary budgets on detailed evaluations, not to blame the service providers.

However, suppose the property’s condition is not (sufficiently) informative about the clause on the maintenance obligation in the purchase agreement. In that case, it is immediately apparent that it is impossible to present the deteriorated property’s condition reasonably.

As a rule, the discussion about the maintenance measures required by law and regulations (inspection, maintenance, repair, possibly even improvement) remains. It is often open to interpretation due to the lack of a clear focus in the transaction on the operational issues of the property.

On the other hand, since the demand in such cases comes from the landlord, he must specify his expectations and derive them in a legally convincing manner. Unfortunately, it is often difficult to do in the light of reports that do not contain any statements. As a result, the landlord’s likely enforceable claims regarding the identified maintenance needs play a subordinate fraction.

In terms of negotiation tactics, do not underestimate this situation because, after communicating the initial positions, the parties usually initially assume that they will primarily go along with each other and perceive any compromise other than 50/50 as a defeat in any case. However, this is not even close to being the case in many of these cases. In addition, a judicial resolution of the issues in dispute is likely to be a suitable alternative in the rarest of circumstances.

That would be required to lead to very long proceedings, which would generally not serve either party regardless of the outcome of the proceedings. Court proceedings are hardly suitable for clarifying such specific issues.

Lease Agreements Should Focus More On The Requirements Of Real Estate Operations

Recent experience in dealing with triple-net contracts and other atypical commercial leases at the end of the contract shows that it is of enormous importance to address the legal issues of facility management in detail when concluding lease agreements.

The experience gained in this respect when commissioning FM service providers in outsourcing can be excellently transferred here. However, only if the range of tasks of both parties is sufficiently clarified and taken into account in the contract can unpleasant surprises be avoided at the end of the contract term.

Companies that currently have ongoing triple-net contracts or other atypical leases in their portfolio address these issues early on before the end of the contract term. This way, you can decide which measures you have to utilize for smooth handling at termination.

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