NNN cap rates in Houston area?

[Robert Scholl]

Curious if anybody knows typical cap rate ranges for NNN leases in the Houston area, for say a corporate tenant like a Walgreens or CVS. A friend of mine is curious on a deal he saw. Thanks.

[Joel Owens]

Hi Robert,

I can write a book on NNN investing. I might some day when I get around to it.

I will take specifically you mentioning pharmacies and talk about nothing else. Walgreens and CVS I will expand on but leave out Rite Aid as it is not investment grade BBB- or better like the other 2.

The cap rate with the pharmacy doesn't matter as much as you think. With pharmacies it's all about the debt structure and lease term.

You have NNN absolute do nothing leases and the landlord gets a check. Then you have NN leases where the landlord is usually responsible for roof, structure, parking lot ( whatever is in the lease). Then you have a ground lease where you the landlord lease the land but do not own the building. The building reverts back to you by default generally if the tenant does not renew the option period after primary term ends.

You can also have just a payment stream as a go between for the tenant and the landlord like a bond. These have more risk and hard to get funding for.

Then you have what we call ZCF or ( zero cash flow ) deals. This is where the lease payment equals the mortgage payments for zero cash flow. The better ones have the zero cash flow end with the primary term of the lease and zero's out. Some have loans expiring before primary term ends and you can be in a negative cash flow situation with having to get new debt at a higher rate so many sell before then. The ZCF is a tax strategy play. I won't go too deep with it here. There is a pay down re-advance feature in some cases allowing you to pull out money tax free and re-invest. Example a 5 million ZCF with re-advance feature in the lease has a seller selling with 1 million equity payment to assume the lease. A developer puts 3 million in and then takes 2 million back out to reinvest proceeds.

If your friend is looking at what I think at an 8.58 cap or something that is a Zero Cash Flow property.

Buyers get excited about all of these ( cap rates) things without knowing how these properties work.

You can also have a high cap say a 8 cap but then find out there is a loan that has to be assumed at 7% rate leaving no cash flow because if not there is a huge penalty to pay it off early. The penalties can be staggering sometimes 1/2 a million or higher.

Even if no loan to assume you can have an 8 cap but then there is only say 10 years left on the lease. They will only give you a 15 to 20 year amort. as they want the loan paid down heavily before option periods kick in so that loan balance is close to dark value. This way it limits lenders risk exposure and losses. Since pharmacies CVS and Walgreens have virtually no rent increases in their 20 to 25 year primary terms making sure the debt is long term of the lease is key. If not and you have to sell you could get crushed with a loss having to move the cap high enough to entice a buyer to purchase.

Other NNN properties work completely different than this. I have not even explained everything with the pharmacies. You can get in as little as 10% down payment depending on many factors.

I hope it helps Robert. My clients let me look through things for them because I already know something won't work because of this or that. You do it everyday and you get very good at it. Brand new pharmacies and even existing are trading in the 5's to 6's range in cap. Debt is at 4's to 5 so with lender phantom reserves you might eek out 4 to 6% pre-tax cash flow and each year you are just generating pay down. There are some value add plays with pharmacies but my fingers are wearing out. Time to hit the hay.......... : )