I am often asked why investors buy NNN properties? What are the advantages and disadvantages?
“Triple net leased” or “triple net” refers to the lease which stipulates that the tenant is responsible for everything. Tenants pay rent, taxes, insurance, and are responsible for the interior and exterior of the building. NNN properties are entirely management free. You own the property, with its tax advantages, and you receive an income check each month long term.
New NNN leases with single-tenant retail tenants are typically 15 or 20 years in length. Depending on the tenant, there may be increases to the lease payments every five years, annual increases or no increases during the term. Investors often like a very long lease, and no worries of shorter-term changes, vacancy or managing turnover that occurs in office buildings, apartments or strip centers.
What are typical NNN properties? Burger King, Tire Kingdom, Walgreens, CVS, Starbucks, Publix, Applebee’s—this is a small sampling of the typical NNN property. Some properties may be NN (double net), which normally means you are responsible for roof & structure and they are responsible for everything else. I will blog about NN in another post. Note that some office properties or government properties may be NN or NNN.
NNN retail properties may be found in valuable locations (corners, high traffic count roads). But a study of the actual demographics, the population and its growth or decline in this area, the competition, etc. is important. The best location in a smaller demographic may not beat the best location in an class A area.
Since there is no management involved, investors don’t have to necessarily acquire a local property. They could diversify by buying in another area or state, seeking out the best deals (which may not be local).
In fact, some of my clients in Florida like to buy outside of the hurricane zone, while some of my clients in California like to buy outside of their earthquake zone or where the cap rates are better. (California typically has lower cap rates / higher prices for the same tenant deal).
Cap rates (capitalization = annual income divided by sales price) are a good way to compare apples to apples when looking at NNN deals. Today cap rates of single-tenant retail are typically between 7.2% and 8.5%, while from 2005 to 2008 they were 6% to 7.5% (even lower in California). Cap rates are often a function of the tenant’s credit, property, lease, guarantee in the lease and location—as well as the economy and interest rates. So, for instance, Walgreens is a strong, highly rated S&P tenant. Their cap rates are usually among the lowest as the perceived risk is lower in owning one. However, their 20 year leases have no increases during the base term, which could be a downside trade-off for an investor concerned about keeping up with inflation.
Financing is a big deal now – credit markets are constrained, loan to values are down and finding financing isn’t a piece of cake. I work with great lending contacts who specialize in NNN. My advice is to consider buying the highest rated tenant possible (a credit tenant with a corporate guarantee vs a franchisee or mom & pop guarantee). With an excellent tenant, you may be able to leverage 70% …maybe. But most deals these days are closer to 60%-65%, or less if the lender has concerns over the tenant or their rating. Some of my clients have been quoted 50% leverage!
For investors considering an all-cash transaction, you will have more negotiating power to get a better deal. Some are using this strategy, will hold the property until credit markets are improved and then plan to finance/refinance the property later.
Consider disadvantages: real estate is not liquid; if a tenant goes out of business, you will need to find a new tenant, though the location will probably be desirable; some of the stronger tenants have no rental increases over the initial term; financing may be difficult.
