5 Reasons to Buy or Not Buy Net Lease Investments
By Hayden Hulsey, CCIM
Recently our Managing Broker, Mark Hulsey, wrote a great article many people enjoyed titled, What is the Best Real Estate Investment? Today, I want to discuss one specific investment strategy suited for the sophisticated & well-capitalized investor. Let’s talk about Net Lease (aka: NNN) Investments and why they are one of the very best options when building your portfolio. For context, national credit tenants such as Starbucks, Walgreen’s, Jiffy Lube, Arby’s are examples of tenants in net leased properties.
First, it’s important to understand how net lease assets are valued. I won’t go into too much detail here, but there are two primary ways to value commercial real estate – the Income Approach & Market Approach. The Income Approach is most commonly used for NNN transactions. The value is derived from the capitalization rate or cap rate. The cap rate (NOI ÷ Sale Price) is driven by the following key criteria:
1. Tenant / Credit
2. Location / Physical Property Structure
3. Rent / Net Operating Income (NOI)
4. The Lease Structure: NNN vs NN and number of years remaining on the current lease term
5 Reasons to Buy Net-Lease Deals:
1. Passive Investment: Sit back and collect the rent! Zero Landlord responsibilities in an Absolute NNN lease. The Tenant pays base rent, Operating Expenses, Property Taxes, Property Insurance, and repairs/maintenance/capital improvements. When it’s time to repave that parking lot, the tenant is paying. New roof? It’s the tenant’s responsibility.
2. Stable & Strong National Tenants: Many tenants in the net-lease space are far more “recession proof” compared to other industries. McDonalds, for example, will still be selling burgers even when an economy suffers. COVID has shed good light on which tenants can survive a serious downturn.
3. Long Lease-Terms: New lease terms on net-lease deals can be in the 10-20 year range. Many net lease investors we represent are seeking remaining a lease term in the 7-10+ year range. The shorter the lease term, the lower the value and higher the cap rate expectation. In a more traditional office or retail strip center investment, you’ll see a lot of lease expirations in the 3-5 year range, resulting in uncertainty regarding vacancy and long-term income.
4. Tax Benefits & Property Appreciation: This can’t be dismissed and is one of the greatest advantages to all real estate investments. For the high-net worth individual, commercial investments are a great way to help offset some of their taxable income. Take advantage of the tax benefits while the property appreciates each year.
5. Liquidity: Compared to many other real estate investments, net lease deals trade frequently and are traditionally fast deals (PSA to closing: within 30-45 days). NNN acquisitions are often funded with cash and/or 1031 exchange funds.
3 Reasons NOT to Buy Net Lease Deals:
While there are several reasons to invest in NNN assets, there are also reasons to avoid this product category. Here are just a few to consider.
1. Down-Payment: If the deal is financed, many times lenders will require larger down-payments than a typical conventional commercial deal. It’s not uncommon to see LTV requests in the 70/30 or 60/40 range depending on the tenant’s industry (i.e. Quick Service Retail vs. Manufacturing). Naturally an expensive building ($2M+) with only a single tenant can be a bit concerning for lenders if a borrower defaults especially if the location is not A+.
2. Risk of a Single-Tenant: If you have a single tenant building and the tenant vacates, you have no income but still have expenses. There are multi-tenant net lease investments, but many retail tenants like a stand-alone building to avoid neighbors and conflicting interests. Drive-throughs are often easier to design and get approved with a single tenant.
3. Expensive / Capital Requirements: Purchase Price, build-outs (TI), leasing commissions, & carrying costs quickly become expensive and are cost prohibitive for the small to medium sized investor. Trying to find a quality net lease deal under $1,000,000 is almost impossible. $2,000,000 is a pretty common starting price point. You’ll see large big-box retail or industrial net lease deals (Walmart, FedEx, Costco) on the higher end up to $15M+. Most of these net lease properties are situated in ideal locations, so it’s easier to find tenants vs a Class C retail strip center. Many trophy commercial properties ranging from $50M – $300M are office and retail net lease assets owned by REITs and high-net worth families.
Brokering net lease assets is my favorite sector within commercial real estate. It is highly specialized with sophisticated players. It’s a different world compared to the typical office, retail, industrial, land, and multifamily brokerage. These deals trade quickly, much more like stocks. It is not for the faint of heart. Buyers & brokers need to know how to swim with the sharks when trading in the NNN space.
Please understand this article is only scratching the surface of all the pros & cons associated with NNN assets. This is just a basic framework for the net lease category and if you’d like to discuss this topic or anything commercial real estate in greater detail, please don’t hesitate to reach out to me at firstname.lastname@example.org
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