If you’re new to commercial real estate, you might not think about who owns the building whenever you walk into a Mcdonald’s, Starbucks, Dollar General or CVS. Yet, there’s an owner for each of these properties who collects rent from these companies every month. This investor is usually using a triple net (NNN) lease. NNN investments are considered some of the most solid and secure CRE investments you can make. This guide covers the basics of NNN investing, what you need to get started, and the benefits and disadvantages of making an investment like this.
There are several types of commercial leases, and these determine which expenses the landlord is responsible for and which are paid by the tenant. In a triple net lease, the tenant is responsible for the maintenance, operating expenses and insurance of the property, in addition to base rent. The landlord receives a fixed monthly payment regardless of the expenses the tenant must pay to maintain the property. Properties with triple net lease investing are typically single tenant, which means one tenant is occupying the property. NNN investments are considered the most hands-off properties for landlords as they do not have any financial responsibility for the maintenance of the property, nor are involved with property management on an everyday basis.
The leases on NNN properties are usually between 10 and up to 30 years, which guarantee income for the duration of the lease, making these properties some of the safest commercial real estate investments in the market. Corporate-guaranteed tenants like Starbucks, Dollar General and CVS are considered the best types of tenants for these properties, as it means your lease is guaranteed to be paid by a publicly traded corporation.
NNN investments are considered the most hands-off, stable and secure CRE investments. They are viewed as long-term investments and are often purchased with 10 or more years left on the lease. “Many risks and obligations normally associated with real estate ownership, such as maintenance, repairs, leasing and management are the responsibility of the tenant,” Ronald Max, CEO of Net Lease Partners and Strategic Real Estate Advisor at Real Estate Bees, told lev.co. The NNN lease investing market has continued to stay strong in the current climate and has seen very little relative movement in pricing despite rising interest rates, Max explained. “They are great investments for seasoned or novice investors looking for reliable and predictable cash flow,” he added.
Though NNN properties are solid and safe investments, they are not the right choice for everyone. Like every investment, there are potential benefits and disadvantages.
The fact that the tenant is responsible for paying all the property expenses (such as insurance, maintenance and taxes), takes a huge burden off the landlord to cover expenses, including any unexpected expenses or price increases. A NNN lease also means the landlord will not need to deal with any potential issues that arise regarding the property. Many investors who do not want to deal with the management responsibilities involved with multifamily properties chose to invest in NNN properties instead for this reason. NNN leases usually come with a lease of at least ten years. When you invest in a property with a NNN lease, you can plan on receiving steady income for the duration of the lease.
Given that NNN lease properties typically have one tenant, the big risk is that something will go wrong or the tenant will not renew the lease when it expires. “You are putting all your eggs in one basket,” Max said. “This places the cost burden back on the landlord, and re-leasing can be very expensive.” This risk is one of the reasons why the value of a NNN investment is largely determined by the lease duration and the stability of the tenant. Properties themselves may be built to accommodate a specific tenant. A Mcdonald’s, for example, would be built with a kitchen, but repairs would need to be made if a Dollar General wanted to move in.
Given the cost burden when finding a new tenant, most investors don’t buy without a significant amount of term left on the lease, Adam Robbins, also a Strategic Real Estate Advisor at Real Estate Bees, told lev.co. However, in a worst-case scenario, you would then need to backfill the property or redevelop it. Some investors view redeveloping as an opportunity to bring in more income long term. A property with only three years left on the NNN lease will not be worth as much as if a decade remained on the lease. “Speculators might buy with the desire to redevelop the property. The shorter the remaining term of the lease, the better the price should be,” he added.
The price of a solid NNN investment — such as one with Dollar General as a tenant — will typically start at a minimum of $1 to 2 million. While there are properties with a lower price point, they generally come with shorter-term leases and include landlord expenses such as roof expenses, structure, parking lot, and more, according to Kimo Quance, of the San Diego-based realtor company Kimo Quance Group. Lenders will need to make sure they have enough cash to qualify for a loan. “The general rule of thumb is that an investor interested in NNN properties will have to show a net worth of $1 million or greater and liquidity above their down payment in their portfolio, not including the value of their primary residence,” Tomas Sulichin, President of Commercial Division at RelatedISG Realty, told lev.co. He added that there are cases where investors could also qualify if they make more than $200,000 per year. Given that each deal and investor is different, Suilchin advises his clients to speak with qualified commercial mortgage lenders to learn more about the various processes available before making any decisions.
Many factors go into choosing a NNN property. To start, location is crucial. “You want an area with a consistent traffic flow to the property to secure a steady return on your investment,” Sulichin said. You should also consider the strength of the tenant. “You want to attract ones with a clean financial record and a proven record of paying bills on time. The best candidates are usually convenience stores, gas stations and drug stores,” he explained. Leases with a guarantee from a publicly-traded company like Walgreens or Dollar General are considered the safest.
You’ll also want to consider whether the property is general enough to be used by other tenants, as this will impact how easy it is to find a new tenant if you need to. “There are cases where a property is for a specific use, such as a movie theater where re-leasing can be very difficult, so venturing into special-purpose properties should be done by experienced professionals,” Max advised. In general, strong visibility, access and signage will increase the re-leasing prospects, he added. Given the number of factors involved with choosing a solid investment, Sulichin also recommended working with a real estate advisor, especially for new investors. “They can provide you with critical news on the market and offer valuable guidance about location, tenant choice, and the loan process,” he said.
While NNN properties for sale come with a range of cap rates, they are typically advertised with a cap rate of 5.5% to 7%. The higher the cap rate, the higher the risk and potential return on investment. NNN properties typically come with cap rates on the lower end in CRE because they are considered more stable and secure investments.
Once you decide on a property you want to invest in, the next step is to secure financing, unless you plan to pay in full. There are several financing options available for triple net lease investments, including traditional banks, conduit lenders and insurance companies. Some lenders may be able to provide more leverage than others. “For permanent financing, conduit lenders will generally provide the highest leverage, followed by private specialty lenders, banks and insurance companies,” Max said. Banks will generally lend on terms from one to seven years, while conduit lenders can go up to 10. Regardless of the type of lender, however, lenders typically do not like terms that extend beyond the length of the lease, Max explained.
The amount a borrower is able to receive for a loan will depend on three primary factors: the loan-to-value (LTV) and loan-to-cost (LTC) and the debt service coverage ratio, which is the net income of the property divided by the loan payment, Max explained. These factors all depend on the lender, the credit of the lease, the general strength of the property and the terms of the lease. Sulichin added that traditional prime banks are considered the main financing option for triple net investments. “What banks like about triple net leases is that they are long-term contracts with little to no landlord responsibilities. As long as the company is a reputable company, the banks are very willing to finance the properties,” he explained. The strength of the tenant will play a big role in defining the loan terms since they will be the ones paying for all the expenses. The main resources available for an investor seeking the right financing options include the investor’s broker, the bank, and a mortgage broker. “A good broker will have a few financing options lined up for the property they are listing to aid in the sale,” Max explained.
This 14,027 SF property is going for $4,599,000. CVS has been successfully operating in this location for seven years, and there are 18 years remaining on this corporate-backed lease. The cap rate is 4.71%.
Located in Louisville, Kentucky, this property is going for $3,187,000 and there are 16 years remaining on Wendy’s lease. This lease also includes 10% fixed rent increases every five years. The cap rate is 4.35%.
Going for $3 million, this 2,400 SF property has a 20-year absolute NNN lease with 1.5% annual rent increases. The Popeyes drive-through is newly constructed this year and is located in a central location that expects a 6% population growth over the next five years. The cap rate for this property is 4.5%.
Investing in NNN properties can be a great opportunity for investors looking for a long-term and stable investment that comes with reliable and consistent cash flow. There are plenty of options for NNN properties all around the country. For CRE investors seeking to invest in a property of $1 million or more, this route could result in receiving monthly checks from Starbucks, Dollar General and other big names.
