How to evaluate an NNN lease deal?

[Charles Chang]

I have been thinking of doing a 1031 on my SFR rental properties in SoCal with a 3.2 cap rate. After looking at Multifamily units, I discovered commercial buildings with NNN leases that can be as long as 20 years with around 5 percent cap rate. It almost sounds too good to be true. Hands off management and just wait for the rent check? That would be ideal.

Now I understand location and rent to revenue ratio is important.  I would also like to get a lease backed by a national corporation like Bank of America or Burger King.

Assuming I can find a deal that has meet all the criteria, am I missing anything else?

Please excuse me for my ignorance as I have never dealt with commercial properties before but I am very intrigued by the apparent ease of NNN deals.

[Joel Owens]

Hi Charles,

I am a principal commercial broker and an investor myself. Commercial NNN retail is my specialty. I look at about 1,000 a week for clients nationally. I have a lot of CA clients in your similar situation.

CA is mainly an appreciation market like New York with a little cash flow sprinkled in. Lot's of owners have had a run up in equity getting little returns for cash flow. They now want to sell and 1031 exchange into something else more passive.

STNL triple net where you do nothing and collect a check can be a great investment. There are many things you have to watch out for. I focus on the dirt for my clients as I believe location is just as important as the tenants themselves. Example a Starbucks in a weak suburban to rural market that is going for 1.6 million versus a Starbucks in an urban core to strong suburban with excellent demographics for 2.3 million to me is the better buy unless possibly you are local to the market.

Over time the strong locations tend to have stronger rent growth values, the air rights become worth more as density increases and you can build up but no more land,etc.

NNN trade at different cap rates and price points. A Burger King corporate in a great area might be 2.5 million to 3 million and a Bank Of America could run 4 to 8 million. So often potential clients do not know what is possible for the funds they have to deploy or how financing works if they want to use that. I evaluate their situation and have a call where I go in depth on the subject.

There are many,many things to evaluate NNN properly. The lease could be corporate but not guaranteed by all locations. They could not disclose sales. The parent company guarantee could go away say 5 to 10 years into the 20 year lease term. They could have assignment or subletting language that gets them off the hook early in the lease. They could have an early termination right if certain sales thresholds are not met. They could have a co-tenant anchor clause where if anchor goes out they can leave sooner than the option periods. The seller or listing broker could claim NNN but it is really NN where owner is responsible for roof, parking lot, utility lines, structure,etc. I have ran across before where the listing broker or even the owner did not even know what was in their leases! The developer could have baked in tenant improvements at inflated above market rents where if the tenant leaves your down payment is eroded releasing at a lesser rent rate.

A buyers broker tends to get paid by the seller. A buyer might look for NNN properties on their own but they have never bought the asset type and have a limited network to start.

Example:

1. New buyer starts looking on their own and discovers a few companies with properties.

2. New buyer makes contact and finds out that the listing brokerages generally only want to sell what they have listed whether it is a bad, mediocre, or good property to buy.

3. New buyer does not already have lined up commercial attorney for retail, companies to do reports, a vast network built up over decades to find the best properties.

4. Instead of reinventing the wheel the buyer finds an excellent buyers broker who already has all the connections and resources ready to go. This is important when doing a 1031 exchange.

5. The buyers broker looks through thousands of companies and retail owners to try and locate the best properties available on and off market for their client rather than a listing brokerage company just pushing what their company has listed to sell. 

My CA clients the fundamental question they have is do they want to own property in CA for the next 8 to 10 years or longer for the next potential appreciation cycle or do they want to fully cash out for max equity transfer and do something more hands off with NNN? I have found a majority do not want to keep actively land lording, keep assets in a potentially unstable political climate, and only access up to 75% of the properties value versus 100% for a 1031 exchange and go passive.

Within NNN there are many structures for leases, price points, rent increases with timing etc.