What are the risks & benefits of triple-net (NNN) properties? Is it possible to get leveraged returns? What types of properties make the most sense these days?
Clarification added 11 months ago:
What are the best ways to find out what triple-net (NNN) properties are available?
Good Answers (12)
Norman -
Triple Net properties are the best case scenerio in Commercial Real Estate. Why? Because the owner assumes no costs associated with the operational expenses of the property. Ie. Taxes, Insurance and Maintenance - hence the tripple net term.
You do however assume reposnisiblity for items such as the structure, roof and parking lot. So you have to make sure these are in good working order when you purchase and will have enough life in them to carry you through the time period you plan to hold the investment.
The real key to any commercial investment is condition of property, quality of the tenant and terms of the lease.
You want a newer preperty - so you dont have to make any improvements
You want a solid tenant - because a non occupied property is severly detrimental not only to your cash flow bt your resale ability
And you want annual inceases in rent so you can increase thevalue of your holding over the period of time in which you hold it.
A good CAP rate is around 8% anything above that is great! But be wary of something if it returns a 12 or 14% CAP rate. If its too good to be true...You know.
In today's real estate loan market, single or fully occupied NNN properties afford the highest degree of leverage, but low spreads. BUT, a strong lease doesn't bring 8%, but closer to 7%, with some fast food deals going into the 6's. Well, with financing at 6.5% to 7%, there's little room for net spendable, probably in the 5% range.
Sometimes if you look hard enough and can evaluate risk, a good deal pops up. I am looking for equity on a deal with a weak-looking NYSE tenant with 5.5 years left on his lease (no late payments in over 15 years), two strong guarantors and a 9% cap rate. I also found excellent financing at 80% LTV, 6.25% interest swap, and 30 amortization that derived a 14% cash on cash. Reason is lease is too short for a long term holder and too long for a developer, but if you see through it and combine the virtues of each, there's a good deal.
Back to your question, you've have to be able to find a solid spread between cap rate and interest rate to generate a good spendable. Typically, you're in the 5% range but if you get increases, it grows nicely. As to where to find them, there's the internet on a site like Loopnet or in the newspapers, but you've got to look hard and long and have a good idea of what you're looking for. My project; I looked at hundreds of summaries and just happened to read an article about this growing town and a week later I saw the property listed on the internet. Luck? Lastly, the best properties are those that can be financed, so know the guidelines of the lenders.
Mr. Carter,
If you prefer to look for yourself: there is Loopnet.com, Co-Star.com, and a few others.
My suggestion is to speak to a local commercial Realtor. I don't say this because I am a Realtor, but because I have a commercial practice. Good Commercial Realtors really know what makes your market tick, who the "players" are, and will know of investment opportunities that don't necessarily make it to websites or listing services. Along the lines of "if you ever have someone who would be interested in this property, I would sell it for the right price." Additionally, commercial Realtors are the people who can tell you how rents and vacancy ratres are trending now.
A few others mentioned some of the benefits- generally pretty reliable cash flow with limited management needed. That is true, but there are risks, too.
Essentially you are buying cash flows into the future, much like a bond. And, just like investing in bonds, there doesn't have to be a default for you to lose money. The only thing that needs to change is the interest rate. For example, if a property is yielding $100,000/year, and you buy it on a 6% cap (6% current yield), you would pay $1,666,666. (multiply $1,666,666 by 6% and you will get the $100,000/year income).
If the market changes and interest rates go up, that same $100,000 income to a buyer that requires a 7% yield is now only worth $1,428,571. So with that 1% change in interest rates, your property is worth 14% less. Now if you intend to hold the property all 20 years or 30 years until the end of the lease, interest rates can go up and down and you will just ignore it. But if you want to sell it sometime before then, you will be in the same predicament as the guy trying to sell the property to Mr. Hamiguchi, who posted here. They have five years left and are trying to sell at a 9% yield. ($100,000 at a 9% cap is $1,111,111)
Another thing that people often think about these deals, is that even if they don't cash flow at all (all of the income is going to pay your debt on the property) it doesn't matter because at the end you will own the building free and clear. While that is true, you should underwrite most of these deals as if you are going to scrape the building at the end (or better, if you're writing the lease, require that the tenant scrape it at the end of the lease). The truth is that a lot of the buildings are built for a specific purpose that no one else will want after they are gone. If you've ever seen a 30 year old Jack-in-the-Box you will know what I mean.
Regarding leverage, if there is a long lease term left it is definitely possible to leverage these, and with a good credit tenant, you can get long-term non-recourse permanent financing through a good commercial mortgage broker from a life company, rather than bank loan, which is typically shorter and more expensive. I shouldn't have to say it, but I will for the good of the board: Don't borrow at 6.5% to invest in something with a 5.5% return. Unless you are getting positive leverage, save your money. If you don't know what I'm talking about, save your money.
Finally, make sure you know what the credit is that you are buying. You are about to pay literally millions for a little building that you probably wouldn't pay $100,000 for if it were empty. Think about that carefully. Is it national credit or local franchisee credit? And how good is the credit? Recent retailers that have gone into bankruptcy are Sharper Image, Lillian Vernon, Steve & Barry's, Linen's and Things, etc. Think how you would feel if you owned a big, dark, empty Linen's and Things right now. Ultimately, that is the risk that you are taking.
In conclusion, I think that triple net leased properties can have a part in your portfolio, just as you might have a mix of stocks and bonds. But I have seen that many people make these major investments without fully understanding the dynamics of the market, and focus only on cap rate, without adequately considering interest rate risk, length of lease term, credit risk, etc.
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Robert R
New York City attorney and corporate executive concentrating in Commercial Real Estate, Leasing and Litigation
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Retail is a traditional good choice for triple net leasing but as can be seen in this economy, particularly with the recent troubles facing Steve and Barry's, you always run the risk of a tenant bankruptcy.
I will respectfully disagree with a previous poster that while landlord's assumption of structural repairs is common it is by no means standard.
I have done several leases where tenant assumed responsibility for all building repairs.
Fred H
Loan Officer at Bay Sierra Financial, Inc.
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Norman:
I suggest the biggest mistakes investors make with NNN properties are:
(1.) Buying in a market they don't thoroughly understand (because the transaction is presented as "mailbox management" - all you have to do it open the envelopes and cash the rent checks); and (2.) Entering into a deal that does not produce sufficient cash flow today.
Are you considering investing in a property outside your immediate area? Long distance management of commercial properties is problematic, at best!
There are NNN deals available that cash flow with a respectable return - other posters have gone over the numbers. We used to underwrite these with a 10% tenant turn-over, tenant improvement and leasing commission haircut to the gross income. That's pretty conservative underwriting - but this is a market that warrants being careful.
From the gross annual income subtract 10% - that results in the Effective Gross Income (EGI). Then comes line-item expenses for management and reserves for replacement(s) (a rainy day account for a new roof, hot water heater, etc.). These figures are each between 3% and 4% of EGI - again, how conservative do you want to be? The remaining amount is the NOI - Net Operating Income.
Lenders look for a 1.20 to 1.25 Debt Service Coverage (Debt Coverage Ratio). For every dollar of debt service (loan principal and interest) you need $1.20 - $1.25 of NOI. Divide the NOI by 1.25 and you have the amount of money available for debt service. These figures are usually based on annual income and expenses, so you divide that figure by 12 and you have the maximum monthly loan payment.
A present value calculation using 25 amortization and a market loan interest rate results in the maximum loan amount the property will support.
The importance of a solid tenant can not be stressed enough. As pointed out above, an empty building is a bad day at the office. Leases guaranteed by the parent corporation won't mean much if the parent goes BK.
Can these work for some investors? Of course. Have investors gotten burned overpaying (remember - profits are made when an income property is purchased - not when it is sold)? Absolutely.
Stay close to home in a market you thoroughly understand - and invest in a deal with a very solid tenant. At a price that produces the return you seek based on the risks involved.
John M
Insurance Agent at John M. Glover Agency
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Norman,
From an Insurance perspective I have cautioned clients who were setting up the triple net situation that they are relying on their tenants to maintain the Insurance coverage. Although they are normally named on the policy as an additional insured there is still some risk of a lapse without the owners knowlege.
Another way to handle it is for the owner to purchase the insurance but for the tenant to pay for it through a charge back or escrow situation. That keeps control of the policy in the building owners hands.
Siva P
President - Pillar Mortgage Corp./NSA Contractor#10714
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One's you can reverse , indutrial for example , if you can barter fr te exist ing business in the industrial building .
Buying a commercial business , need financing ,look no futher . I am
owner-operator /government contractor that can get the job done !
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2) Over 1000 end lenders.
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Norman:
Net-leased investments ("NNN" properties) have been the darling of the small investor community for some time, which means that prices have reached an all-time high nation-wide. I've been in this business a long time and can tell you that the value of a single-tenant net-leased investment declines as the lease burns off. At the end of the lease, you may be left with a building that is not useful for any other tenant, and the residual value may be only in the land. If you want to park your money in one of these investments, be sure that it is in a "AAA" location where the land will appreciate over time. Free-standing buildings in suburban locations can leave your heirs with nothing but a tax bill. The positive side of a net-leased investment is the lack of effort required to manage such properties. If you want a monthly check deposited in your account, this can be a good investment. However, be sure that the initial rate of return is well above the rate that the tenant's company pays on its corporate bonds, or else you should just buy the bonds, because there is not likely to be any "upside" associated with the real estate investment.
Bob Q
Experienced Banking and Real Estate Executive Providing Clarity and Direction Through Turbulent Markets
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Some risks are:
(1) The underlying lease document. Make sure you have good attornies
(2) The underlying credit of the Tenant
(3) Financing. Be careful on how the lease maturity matches with the loan maturity. A lender might love the tenant and yearly cash flow, but will only see an empty building if lease maturity is approaching
(4) Debt Service coverage tests. Make sure they work, and that your interest rates are hedged relative to the tenant rent.
Light industrial with rated tenants are attractive. Make sure you are in a good area that should provide value increases. Always make sure that the real estate makes sense on its own.
Your value is the value of the discounted cash flow of the lease payments and the residual real estate value. The discount rate can be positively effected by the credit quality of the tenant during the lease term. That could help obtaining optimal financing in terms of rate and amount.
Remember to remind the lender what a great deal they are getting by effectively arbitraging the credit of the Tenant.
I agree with Chris and would take his answer one step further. He is correct and NNN properties can be excellent investments. There can be variations though from lease to lease and what one may call a NNN investment may look completely different in another case. For example, some NNN investments place the burden of the roof and structure on the landlord (investor) while some do not. There are other variations that can come up and so the bottom line is, "read the lease." There is no substitute for thorough due-diligence on the front end.
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Edvard R. R
President, EDVARD COMPANIES
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Tenant, tenant, tenant……
Do your due-diligence on who that tenant is and how they operate because you are going to be together for a long time.
Do they have a sustainable business model?
For example, I like Walgreen’s for now and the future but those new “Fresh N’ Easy” stores scare me as being an unproven concept.
A bit like, Peter Lynch’s advice, insofar as “invest in what you know”. I will regularly shop at a Walgreen’s but despite repeated visits to Fresh and Easy, I do not see myself as a return patron there. Frankly, I just do not get their business model.
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Gary A
CEO at Aminoff & Co. Realty Advisors, Inc.
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Our firm specializes in providing NNN single-tenant leased properties throughout the United States.
I would suggest contacting me privately to discuss your particular requirement. I am sure that we can most likely provide you with a suitable property.
