Skip the Joke, Pass the Costs: NNN Operating Expenses

When evaluating commercial real estate investments, understanding building operating expenses and triple-net (NNN) reimbursements is essential for maximizing returns and ensuring lease structures align with investment goals. Whether you’re a landlord, investor, or tenant, knowing how these expenses are allocated and recouped can make a significant difference in a property’s financial performance.

Building Operating Expenses

Building operating expenses include the costs associated with maintaining and managing a commercial property. These expenses typically fall into three categories:

1. Common Area Maintenance (CAM) Costs – Expenses related to the upkeep of shared spaces, such as, though not restricted to, landscaping, shared utilities, janitorial services, ongoing maintenance and repairs to common areas, and building security.
2. Property Taxes – The annual taxes assessed by local governments based on property valuation.
3. Insurance – Coverage for property damage, liability, and other risks associated with the asset.

Non-Operating Expenses

While operating expenses are directly tied to the day-to-day management and maintenance of a property, non-operating expenses refer to costs that are not part of regular property operations. These expenses typically relate to long-term investments, improvements, or financial obligations unrelated to the building's day-to-day upkeep.

Common examples of non-operating expenses include:

• Major Repairs & Non-Recurring Maintenance – Certain repair and maintenance costs that do not fall under routine operating expenses may be classified as non-operating expenses. These include large-scale remediation efforts, emergency structural repairs, or significant system overhauls that do not extend the asset’s useful life. However, if an expense improves or extends the property's lifespan—such as a roof replacement or major mechanical upgrade—it is classified as a capital expenditure (CapEx), rather than an operating or non-operating expense, and is recorded as an asset on the Balance Sheet.
• Loan Interest Payments – Interest payments on a mortgage or loan used to finance the purchase of a property are considered non-operating expenses. While these are crucial for managing cash flow, they are not directly tied to the property's operations.
• Legal Fees – Costs related to lawsuits, disputes, or legal compliance issues that are not part of regular operational management.
• Leasing Commissions – These are fees paid to brokers or agents for securing tenants for a property. Leasing commissions are generally paid upfront or in installments, and are considered a one-time, non-operating cost that reflects the cost of leasing space.

Understanding the distinction between operating, non-operating, and capital expenses is essential for landlords and investors. Operating expenses are generally passed through to tenants in NNN leases, whereas non-operating expenses and capital expenditures are typically the landlord’s responsibility. Proper expense classification ensures accurate financial reporting and can influence lease structuring and property valuation.

Triple-Net (NNN) Leases and Reimbursements

A triple-net (NNN) lease shifts the financial burden of operating expenses from the landlord to the tenant. In this structure, tenants reimburse the landlord for their pro-rata share of property taxes, insurance, and CAM expenses in addition to their base rent. NNN leases are commonly used in multi-tenant properties or smaller single-tenant assets where the landlord retains some operational responsibilities.

For large, single-tenant properties, such as industrial or corporate headquarters, landlords often prefer absolute net leases, where tenants assume full responsibility for property-related expenses. This structure provides landlords with a completely passive investment, eliminating the need for expense reconciliations and limiting property management oversight. Read more on differing lease structures in our previous article, CRE Lease Structures.

Key Benefits for Landlords and Investors:

• Predictable Net Operating Income (NOI) – Since tenants cover operating costs, landlords enjoy more stable cash flow.
• Lower Financial Risk – Fluctuations in property expenses are absorbed by tenants rather than the property owner.
• Asset Value Optimization – By passing expenses to tenants, landlords can maintain profitability and increase property valuation.

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Calculating NNN Reimbursements

Reimbursements are typically calculated based on a tenant’s proportionate share of the property’s total leasable square footage. Here’s a basic formula:

Once the share is determined, the landlord applies it to the total operating expenses to determine the tenant’s responsibility:

Common Challenges and Considerations

• Annual Reconciliations: Operating expenses can fluctuate year over year. Most leases include an annual reconciliation process where landlords compare estimated expense payments collected from tenants throughout the year with actual expenses incurred. If tenants have underpaid, they are billed for the difference; if they have overpaid, they receive a credit or refund. This process ensures that landlords recover their actual costs while maintaining transparency with tenants. Proper documentation, such as expense reports and audit rights, is crucial to maintaining trust and avoiding disputes.
• Expense Caps & Exclusions: Some tenants negotiate expense caps or exclusions, limiting their exposure to increases in certain operating costs.
• Capital Expenditures vs. Operating Expenses: NNN leases generally pass through operational costs but not capital improvements. However, some leases allow landlords to recover capital costs over time through amortized charges.

For landlords and investors, structuring operating expenses and NNN reimbursements properly ensures financial stability and enhances a property’s long-term value. Whether you’re acquiring, leasing, or managing a commercial asset, a firm grasp of these concepts will help you optimize profitability and mitigate risk.

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