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A Brief Introduction to Triple Net Investing

May 26, 2013  |   No Comments Yet

Given the wild swings in virtually all investment sectors over the last several years, many investors have sought a relatively safe and predictable place to put their money, while still generating a healthy return. For many, single tenant triple net lease investments have satisfied these criteria and, as a result, demand for the product has soared to historic levels.

If you are unfamiliar with the concept of single tenant triple net lease investment (sometimes referred to as NNN), you’re not alone. Many are unaware of exactly how the investment works, but it’s likely you are very familiar with the users. Throughout the course of your day, you walk through countless NNN investment properties. A day comprised of grabbing coffee at Starbucks, an oil change at Jiffy Lube, picking up a few items at Dollar General, Home Depot, and CVS, capped off with a dinner at Applebee’s means you have probably just walked through five net lease investments.

 

What is a NNN Lease?

A NNN lease is an agreement that obligates the tenant to pay full rent and all expenses associated with operating the property including taxes, insurance, and maintenance items (new roof, resealing a parking lot, etc.). In its simplest form, it’s a lease structure in which a tenant operates as if they own the real estate and promises to pay all the bills associated with that real estate until the lease expires. Of course, they don’t own the real estate, the investor does—with this type of lease in place when the property is purchased—and this is one of the benefits owners find so appealing.

 

What are the Benefits of a NNN Investment?

A property with a NNN lease offers many of the advantages of traditional real estate investments, such as cash flow, equity buildup through debt reduction, and tax benefits, but most select this investment vehicle for four primary reasons:

  • Stability—While not always the case, the most popular NNN investments are financially stable and often credit rated tenants backed by some of the strongest companies in the nation (think Walgreens, McDonalds, 7 Eleven). The size of these companies places them in a good position to maintain their lease obligations and additional backing is generally found in the form of a corporate or personal guarantee, which allows a landlord an additional source of recourse in the event of default. The corporate guarantee is preferred for reasons discussed later.
  • Predictability—By their very nature, NNN investments allow investors to predict the future with a reasonable level of certainty. The lease agreement outlines the annual rent, term (number of years that rent will be paid), how much the rent will increase over the term through escalations or percentage increases, and eliminates landlord responsibility for operating expenses. In essence, this type of lease largely eliminates the variables found in other types of investments like multifamily or strip centers.
  • Simplicity—The elimination of expenses is by far the most popular aspect of NNN investments. Not only are expenses associated with taxes, insurance, and maintenance no longer a landlord responsibility, but many find this also translates to the elimination of professional management since most operations requiring these services are not present. In addition, financing a NNN property can often be an easier task based on the structure of the agreement and some lenders have special rates and programs in place.
  • Flexibility—The basic concept of a net lease investment is consistent, even across different business sectors, but there are differences between various companies, locations, and lease terms that permit an investor to determine which best fits their risk tolerance and preferences. For example, a brand new CVS with a 50-year lease will cost more and yield less than a weaker Rite Aid with six years remaining on the lease as a result of differences in the corporate stability (often defined by credit rating agencies) and number of years the income is anticipated. As a whole, the current NNN market will provide properties that will return between 5-10% on an all cash purchase and comparable cash-on-cash returns for financed purchases based on the company, location, term, and property, among other factors.

Some people benefit by viewing this type of investment as analogous to a bond. Given the strengths listed above, you may agree this is a fairly apt description.  Taken together, these components have the potential to create a passive investment in which the landlord has secured an increasing and predictable monthly revenue stream from a well-known tenant for a long period of time.

 

Risk is Always Present

It may seem nothing could be simpler than a NNN investment. Some even market this type of investment as “risk free”. Of course, there is no such thing as a risk free investment—and a compelling argument could be made that a NNN property requires substantially more research than any other investment property. Much like the protagonist in a Shakespearean tragedy, the primary strengths of the investment may also be the greatest source of potential weakness.

 

Keep in mind that NNN investments are often long-term leases structured for properties occupied by a single tenant subject to the whims of consumers and, consequently, the strength of the company over that term. A company can go bankrupt or choose not to renew a lease. In such a scenario, every benefit outlined above can be undermined if not properly researched and analyzed. Understanding the corporate strength and lease terms is vital, but ultimately it’s still the real estate you’re purchasing and it’s imperative the purchaser has an understanding of what makes the site good today and into the future. For this reason, it’s important to have an experienced team in place to help explore all aspects of the investment including the market area, subject property, lease language, and corporate strength.

 

Who Buys NNN Property?

Many NNN investors have previously owned other types of real estate but are looking for an investment that provides a more passive form of income. A recent survey suggested buyers are mostly “non-institutional investors who are making little to no money on liquid cash or in the stock market and are either buying property or getting into the [investment] as an alternative to other sectors or classes,” which has also been my experience. For example, many multifamily owners shift from their higher maintenance properties to NNN investments through a 1031 exchange. In Harrisonburg and the Shenandoah Valley area, several NNN investments have been purchased over the last two years including 7-Eleven, Sheetz, Applebee’s, O’Charley’s, Ruby Tuesday, Family Dollar, and Taco Bell to name a few.

 

An investor that purchases the real estate, when accompanied by this type of lease agreement, creates a potentially long-term investment vehicle capable of producing positive cash flow, while reducing outstanding debt on the property and yielding tax benefits.  However, like any other investment, make sure your team takes a comprehensive approach to the selection and review of a property that fits your long-term goals.

 

Tim Reamer provides commercial real estate brokerage and consulting services with Cottonwood Commercial and specializes in investment property (multifamily | commercial | NNN), retail/restaurant site selection, and commercial buyer/tenant representation. Learn more at www.timreamer.com. 

 

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