Absolute Net Lease tied to a residential property - pros/cons?

Question

Hello all,

Thank you in advance for your feedback. I am seeking information on a potential deal I came across. The asset is a Residential home that is leased (absolute Net) to a medical treatment facility. I am familiar with the corporate NNN leases (primarily QSRs) but I have not seen this type of deal before.

Some high-level details: Lease term is 11 years left out of 15.

Cap rate: 6.5%

Leased to a Nationally recognized tenant. Questions/comments:

This type of deal vs a QSR-type NNN feels better- since the underlying assets is a residential home in a local real estate market I know well. So the growth of the home should be tied to the growth of the local RE market (as compared to a stand-alone NNN).  This house sits in a desirable area, and should the tenant move out, I could easily move into, sell, or rent the property to a local family (albeit at a much lower cap rate).  This feels safter than buying a QSR. Thoughts on this logic?

Loan: For this type of deal does anyone know if you could get residential financing? or would you still need to go the corporate route?

Tax: Are there any tax benefits from this type of deal vs a QSR-NNN corporate deal? I am assuming you can take depreciation at 27.5 years vs. 39.

I appreciate any help the forum can provide.

Evan Polaski · Answer

@Kevin Gil, I can't help but compare this to people trying to sell residential properties that THEY chose to airbnb for a much higher price than surrounding properties, simply because they were making more income from it.

So to Michael's point, at the end of the day, you are left with a single family residential property.  The residual value of the property is not going to be more than any other single family in similar condition in 11 yrs, if the tenant does not renew.

From there, I would look at that estimated value, less any costs it will take to make it a "normal" SF home, assuming the medical treatment center has done some custom work to the house, factor in my cash flow that I can get for the next 11 years, and back into a value for the property.

Another thing I would consider: the deal is NNN during their lease term, but assuming they leave, what are your estimated capex bills?  I.e. if furnace was new when lease started, it will likely be at end of useful life when lease is over, but quite possibly NOT before lease ends.  As such, you will have a 15 yr old furnace to replace.  Again, no difference any other residential or commercial property, but something to consider.  Same with everything else in there.  And not knowing how this property is treated, relative to a typical rental of a SFR, you may want to look at their lease to understand what condition is expected to be returned when the lease is ended.

Steven McPherson · Answer

@Kevin G.What is the current zoning of the "home"?

Kevin G. · Answer

Thank you for your reply!

Alecia Loveless · Answer

@Kevin Gil It should I believe just be financed as any other residential property. In my town we have 5 zoning districts. There are certain allowable uses in every district. You can do most of them from a residential home but it is still a home it doesn’t make it a commercial property. For instance there is a hair salon in one home but it’s still classified as a home. So if I bought it I could get a mortgage on it as a SFH.

Or when I bought my duplex it had been office space for 10 years but I immediately turned it into residential space.

I work at a treatment facility and have worked at several over the past 15 years that have all been in large homes and they’re owned by large corporations but they’re viewed as residential entities.

I think it’s a sweet deal that you’ve got a long term lease with them where they’re responsible for most everything regarding the property.

Michael K Gallagher · Answer

@Kevin Gil interesting deal, I'm guessing your question around financing and if you can use traditional residention or not is going to depend on zoning.  If its bee re-zoned to a commercial only type use then i can see underwriters having a hard time with it.  However if there is still the legal use of a residential building, as long as it would make it through appraisal I don't see why you couldn't use a standard 20% down residential loan.

However, if you are currently evaluating the building as a commercial deal, ie NOI and cap-rate as it appears you are from your question, then I'd be interested to understand if the comparable approach of valuation will lead a similar price/value.  That's where I can see you coming into issues with traditional financing. You are valuing it under the commercial theory for the purchase price, but if its a residential loan the appraiser is going to use a standard comps approach.

I agree with your logic though that in theory its a less "risky" investment in that there are more flexible exits and re-uses.

When comparing to a QSR my first question would be if you are buying just the building and there is a ground lease in place, or if you'd be able to purchase the dirt as well.  If you can purchase the building and the dirt, and the building is in a traditional QSR location such as a grocery anchored center out parcel, or a hard corner, those type of prime locations are often worth getting and holding onto.  Even if you can't get another QSR to backfill, you can always scrape the lot, and ground lease it to someone else, or you can backfill with a bank or retail medical tenant if the parking, and such works for that use as well.  I guess my point is that I wouldn't be so quick to dismiss the QSR if you are getting the dirt and if its in a traditional QSR location that has flexibility of use.

Absolute Net Lease tied to a residential property - pros/cons?

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