The ups and downs of a single tenant NNN Lease property

[John McKee]

Bought a property in 2005 that was an absolute NNN corporate restaurant lease. For 11years they paid rent like clock work, then one day they shut their doors and did not fulfill the rest of their 15 year corporate term. They had 4 years left and decided to give me only 1 year of rent on the remaining term in their shakedown negotiating. It took 1.5 years to find the right restaurant tenant (franchisee). I chalk it up to the Lazy brokers that took the listing. Tenant struggled a bit and then covid hit. Tenant could not pay taxes and had to give him a break on rent. I was on the hook for the roof and some other structural repairs now that I owned the building. My IRR was starting to see some cracks and further rent reductions were needed to keep the tenant running. Luckily I knew the land was valuable, but I had to hang on. I just didn't have the time to do the work which was to redevelop the property. I had to come out of retirement recently to put some work into stabalizing this property so I started dialing like a hungry broker to find a deal. I finally landed a deal with a Major Restaurant group with strong sales and negotiated an absolute NNN lease for more rent for the next 10 years. The downside is that I have to put in $480,000 Dollars of TI and brokerage fees, but the upside is that they will be putting in 1.5 million to redesign and improve the existing structure. 10 years from now I might have to go through the same thing, but I wanted to give you an example of how things can go wrong at the end of these leases.

[Joel Owens]

Yeah we own many properties and some leasing brokers are good and some are lazy.

I would challenge the (A) location taking 1.5 years to fill. If it's an (A) location you do not need 1.5 years especially to land a franchisee restaurant tenant.

When I look at a property I look at the current value, the dark value, and the re-potential value.

Lot of commercial developers sell off marginal tenants at market rents.

Example me buying a Wal-mart with 10 plus years left at a 7 cap is way different than trampoline or workout place at a 9 cap.

On its face the 9 cap may be appealing but then you find out for that box size the crap tenant is paying 1 dollar below what national tenants pay. That weaker tenant agrees to anything just to get in a space. The property is then sold off to a sucker. The tenant goes dark and now you have to back fill it with 500k to millions in cost. Guess what since previous weak tenant was market rent you are losing your ***.

I look at high cap stuff when it's few years left ( blend and extend ) or it can be weaker tenant at higher cap rate like 10 cap BUT I want them paying about half the going market rent for the building size or less in that market. That way I win both ways. If they stay and pay I get an ultra high return. If they go out I can raise rents to still below market a little for a good deal to a tenant but after my lease up expenses still have additional equity and value to show for it.

I shake my head at buyers buying Popeyes with some small franchisee that is 6.2 cap rate versus national grade credit at 5.9 cap and that Popeyes paying market rent. Those developers pray long enough while building out the building that the tenant will open and they can sell it off before taking a bath on it.

The small to medium franchisees eventually if the have trouble get bought out by a Private Equity group that runs them like sh*t and makes their money back and sucks any remaining profit dry before they close or ask landlord for rent reduction.

That's what 20 years experience teaches you versus buyers just looking at a cap rate thinking something is a good deal. You could look at a 20 cap (being funny) but if the 10 year lease they go out in year 2 it didn't mean squat.

We are taking down investment grade tenants all cash with my core plus syndication 200k minimum per investor. Works out to be about a 6% cash on cash return to LP's which they love. Multifamily syndicators many pausing distributions so investors getting hosed on those for years and now they seek safety.

What's awesome about investment credit grade tenant is what you model out is typically what you get. Multifamily you can win big or lose your *** it's all about if you already made your money with your career, business, investments already and want to be safer.

Right now owning NNN yourself without a syndicate is tougher especially in the smaller 4 million and below price ranges. The reason is a 5 cap might have risen to a 6 cap but the debt still at 7 s underwater on spread. That makes down payment of 30% when cap rates 5 and interest rates 3.5 now 45% down with huge interest payment to make DSCR work with lender and only get cash on cash of about 3.5% and buyers say that suck I get 5 in the bank no thanks.

Now in bank they get highly taxed on the 5 and some banks unstable right now depending on who they hold funds with. You could say they are FDIC insured to an extent but claims to be made whole on a failed bank to get reimbursed by the FEDS can take a very long time in some cases.

The NNN even if return was 5% you have hopefully property appreciation value long term, tax depreciation against the asset, rental increases, etc. you do not get with the bank.

So my clients unless they are buying say a 6 million and up single tenant where I can land 7 plus cap rate above the debt a little those smaller deals sub 4 million do not work unless they are paying all cash or have a tiny loan like 25% LTV so the high interest rate does not affect cash flow that much.

So what if someone HAS TO buy with 1031 for large taxes. Usually we get loan with little to no pre-pay penalty and maybe they hit 4.5% cash on cash return going in and then when hopefully rates drop in a year or two they can refi and push cash on cash to 6 to 8% while being passive.