Evaluating Deal-Class A tenant (NNN lease with percentage sales)

[Joseph Dzwiniarski]

Brief background - My family will need to 1031 a property in the near future and will need the income to live off of. I'm already managing 2 of their rental properties and will not have the capacity to do a third. As such, I was looking into commercial properties that have Class A tenants on long term triple net leases. It seems like this may be a better passive investment while getting a slightly higher cap rate in my market today.

There is one property that peaked my interest that was given to me as an off market deal. The deal is a percentage of sales lease with a widely known class A franchise in the restaurant/food industry (sale lease back). The area isn't the most prized, but there is a lot of traffic which is good for the business. Essentially this lease is like buying a minority interest in the franchise owners business. The franchise owner has a strong credit history has over 20+ stores and the sales of this location appear to be strong. I'm requesting sales and net income for the past 10 years to confirm this assumption. My strategy would be to hold onto this property for 20 years while my parents receive the income and then cash out when the market is right.

Rent: 8% gross sales

Cap Rate: 6%

Base Term on rents: 11 years with 3 10 year options.

In my projections I'm assuming sales increase 1% a year below 3.5% inflation.Using this conservative assumption IRR is close to 9.5% over 20 years (assuming an exit value with 7% cap).

Does this sound like a good investment strategy? Obviously there are a ton of pitfalls if sales fell, which is why I want to do my due diligence on the company, but it seems like a pretty decent passive investment strategy? I would love to hear other people's thoughts? 

[Joel Owens]

How much is your family exchanging and what is the sale price of the replacement property?

What concept is it?

All I do pretty much is retail. I am a commercial broker and small balance retail developer.

Franchisee anything under 50 units generally a lender will not give the greatest terms. They typically want 35 to 40% down for STNL.

If it was corporate guarantee and BBB- investment grade or better tenant then loan terms tend to be better with less down.

Would require operator to give personal guarantee. 20 unit operator means nothing if they do not personally guarantee or they can put lease under just 1 to 4 stores for guarantee.

Would want rental increases every year. 1% rent increase is generally reserved for corporate. Franchisee wants to see 1.5 to 2% each year and not blocked rent where it goes up every 5 years. Blocked rent is usually reserved for corporate tenants. 

If it's a sale leaseback 11 years is crappy. Usually 15 to 20 years for primary to start. Cycle happens about every 7 to 10 years. This way you can time right time in the cycle to exit and still have about 10 years left on primary term which is still marketable in most cases. If sub 10 years and you want to sell the cap rate starts rising because buyer cannot get good loan terms from lender and must buy cash or put a lot down with a short amortization schedule.

6 cap for franchisee is not good. Needs to be mid 6 cap or better to start. Sale leaseback the terms offered are what tenant would like. Buyer needs to counter with what they deem optimal and try to find middle ground both can accept. Make sure tenant reports ongoing store sales,overall company sales for all units, and personal updated financials.

Do not allow early termination clause and make sure triple net and not double net. If double net cap rate needs to go much higher to compensate. 

You need a marketable lease when you exit later on and if the tenant gets all their way it can hurt you in the long run for resale.