My "triple net" tax reimbursement had a ceiling the reassessment blew through

I closed on a 9,600 square foot single tenant retail box last year, a discount general merchandise user, small town, corporate lease with seven years left. Rent $170,400. I paid a hair over $2.4M, so about a 7.0 going in. I hold land and long term stuff and this was supposed to be the boring part of the portfolio.

The lease says triple net at the top of page one. I read the reimbursement section and it said the tenant reimburses real estate taxes. What I did not read carefully enough was the sentence after it, which capped the tenant's tax reimbursement at $1.25 per square foot per year, growing 3 percent annually, with the owner responsible for anything above that. So the cap was about $12,000 a year against a tax bill that had been running about $21,000. The seller had been eating $9,000 a year and it was buried in the operating statement as an owner expense line I glanced at and assumed was insurance or something. My fault entirely.

Then the county reassessed after the sale. Whether a sale triggers a reassessment depends on the state and sometimes the county, and in mine it does, and the new assessed value was pegged much closer to what I paid than to whatever the old basis was. New bill came in at just under $46,000. Tenant's cap covers $12,400 of it this year. I am paying roughly $33,000 a year out of pocket on a building I bought as hands off income.

That takes my $170,400 of rent down to about $137,000 net. On $2.4M that is a 5.7, not a 7.0. Over the remaining seven years it is somewhere north of $230,000 assuming the assessment holds, and I have filed an appeal, which may or may not go anywhere.

What I would do differently. I would ask the assessor's office what happens to the assessment on a sale at my price before I go hard, in the state where the property sits, because the rules differ. And I would read the reimbursement section for ceilings and base years rather than for the word "net." A lease can say triple net in the header and still park a five figure annual expense with the owner. I am talking to a professional in that state about the appeal, and I should have been talking to one before closing instead of after.

5 replies

3laurenkim53Passive

This is the thing that makes rural deals look better than they are. In the small counties I look at, assessments can sit stale for years and then move all at once when something sells nearby, and how and when that happens is a state by state question. I've gotten in the habit of pulling the assessment history for the parcel and the three closest commercial parcels off the county site before I make an offer. When one of them shows a big jump right after a sale date, I know what's coming. Sorry @orchard, $33k a year is a real hit.

1diane_kowalskiPassivePRO9

Same habit here from the land side. Assessors publish a lot more than people expect, and in some states you can see the pending value before the bill goes out. Worth saying though, roughly a dozen states don't make sale prices public at all, so in those you're guessing at what the reassessment will key off. Which state were you in, or would you rather not say?

1brandonlee36Passive

I now ask for three years of tax bills and any appeal history as part of diligence, and I ask specifically whether the seller has an appeal pending. Found out on one deal that the seller's low bill was the result of a successful appeal that was expiring. Nobody lied to me, it just wasn't in anything I was handed.

1stephen_ok9CO2CPRO6

The structural lesson for me is that "triple net" is a marketing word and the reimbursement clause is the actual document. Caps, base years, exclusions for roof and structure, and administrative fee limits all live in there. I've started underwriting a landlord expense line on every net lease deal even when I'm told there isn't one, because a zero on that line is an assumption and it should have to justify itself.

2bmoreno23AB1B

Coming at this with basically no background, can someone explain the cap in plain terms? My reading is that the tenant agreed to pay taxes only up to a fixed dollar amount per square foot, and everything above that is the owner's problem, so if the tax bill doubles the tenant's payment barely moves. Is that right, and is that a normal thing to see or did @orchard get an unusual lease?

My "triple net" tax reimbursement had a ceiling the reassessment blew through

5 replies