Hold Or Trade? 13 SFR for NNN Commercial

[John Thedford]

I have been a SFR investor in Cape Coral, Fl for the past few years. I have a SFR portfolio of 13 houses-12 in Cape Coral and one in Lehigh Acres. I am considering trading out and moving into some industrial space. This would be HUGE for me so I need all the input on this idea. I believe the portfolio can net about 200K+ next year. I think the portfolio is worth about 3.5m+.

Why this idea now? 13 roofs vs 1-2 roofs. If I buy NNN all the maintenance costs, etc get passed on. If I continue to hold the portfolio I will have to start replacing roofs in the near future.

Another consideration is where is the commercial market headed? Houses are still off the chart. 

[Joel Owens]

John it's a complex question based on an individuals circumstances.

First people need to separate ACTIVE yield versus PASSIVE yield when owning a property directly. Not talking about investing in a syndication but where you own the property 100% yourself.

Often I see investors compare active versus passive properties as similar and want to just accept a few percent less yield with passive and with supply and demand it doesn't work that way. Investors often focus on returns but more important is where the investor is in their investing and also age in years life cycle. That can have implications along with current cash flow and net worth if they want to be in wealth growth phase, stabilization, or preservation.

Commercial market and where it is headed is based on tons of factors. Is that state growing or declining? Warm belt or cold belt state? Rural, small suburban, strong suburban, urban core area? Population in 5 mile radius? No income tax state? High or low income and how is crime?

Literally could add dozens and dozens more to this analysis. You get into cap rate values by state, price range, asset type within NNN, remaining primary lease terms, lease guarantee strength, etc.

A bunch of industrial is not absolute NNN like other types. There are some but you have to be careful as the smaller tenant can have outdated warehouses with functionality and structure. If they go out the national tenants would not want the space so could sit for awhile. The national industrial NNN is usually massive in price like 8 million low end and up to 50 million high end like an Amazon. Cap rates are really low too as lots of investors are chasing that sector.

200,000/ 3,500,000 assuming this portfolio is paid off with no mortgages then about 5.7% annual return for active investing which isn't that great. If you wanted to retire and go all in I would stick to national credit grade investment grade BBB- or better tenants with minimum 10 plus years remaining on the primary lease term. You can typically get fixed debt with 30 to 35% down with a 30 year amortization and interest rate fixed at about 3.5 to 3.65 for 10 years. What cap rate for investment grade depends on the state you are buying in and the price range. A ton of buyers for 3 million and below properties putting 1 million down and loan for the rest. They owned apartments, houses, etc. and do not want to deal with it anymore. If an investor has millions with an exchange they can have more leverage to buy a higher priced property with less buyers at higher cap rate ( instead of 5.0 to 5.3 maybe 5.5 to 5.9 cap) and better dirt value location being on strong suburban to urban core location instead of small suburban middle to fringes.

Another factor to consider is depreciation. There are tax engineering companies that can do advanced cost segs for interior electrical and plumbing. With the Trump bonus depreciation through 2022 currently some savings can be up to 35% year one for a Davita Dialysis for example. Pharmacy usually up to 30%. Gas stations and car washes can be even higher for tax depreciation. This can be a big benefit for someone with real estate professional status that typically does not have a cap writing down personal income from property depreciation.

I am not a tax expert not give legal or tax advice. I let clients talk to the companies doing the tax cost segs for answers and their tax accountant. The tax accountants when they do cost seg can be limited on what they depreciate. To do plumbing and electrical that is done by engineers. Tax accountants can outsource that part of it but generally have a markup for themselves. Often if you go to the cost seg company you end up paying the same or less and some of the companies include audit defense for free in their overall price charged versus the accountant subbing it out to them to do the engineer part if there is an audit the accountant will charge usually per hour additional money to defend.

There is nothing to say you have to sell all those houses you could sell some and then buy say a 3 million type property NNN. In FL cap rates are more compressed due to no income tax state just like Texas. I see quality property at 6 million NNN for 5.2 cap rate in FL with investment grade tenant that has 2% per year rental increases.

With inflation coming active yield investments for sure likely have more rent growth to offset inflation. The question becomes at that point in a persons life do they care about that and do they want to work for that yield? Often clients in their 50's to 60's in age the answer is NO. They have already made money and have enough to be comfortable. If they are getting 5 to 6% cash on cash going in for NNN passive and with mortgage paydown hitting 10% annually they are happy. Some buy the NNN to own themselves as the base for security and income and then take a few hundred k here and there and invest in syndicates. That way they blend the portfolio overall return higher over time but still stay passive. These days I value time at 46 years old a lot more than money. I like money of course but value time to create those memories with others that might have a smaller window on this planet to live life.