Leaving multifamily investing- What NNN props do you recommend?

[Mike Nas]

Hey everyone! Im a new member here but after stumbling here for another reason Im hoping some people can help with some suggestions. Will try to keep this brief so let me know if you need any more information. 

I come from multi family (MF) property ownership/management of a few properties of various sizes here in Los Angeles. Im looking to exchange the MF properties over time into STNL properties, perhaps in tax-friendly states. I have a pretty good knowledge of the MF business but admittedly not too much in the general commercial space. 

With that said, is there any "gold standard" for STNL? What kind of properties do MF landlords (who are tired of tenants and toilets) like to exchange into (i.e. properties that are good for new CRE investors)? Drug stores and Walgreens in particular seemed very promising until I quickly realized that rent increases were often flat for decades.

I am having trouble understanding how the relationship between risk vs return actually plays out in real life because cap rates and valuations seem to vary so widely. Unlikely, but is it because many of the properties on loop net are priced in way (high) where the landlord just wants to see if there are any bites vs people who are actually motivated to sell. Are off-market listing more common in commercial properties than in MF? 

[Joel Owens]

Hi Mike,

This is my wheelhouse. I review about 1,000 retail properties  a week nationwide for my clients. Expected returns and risk profiles vary by investor. I generally talk to investors over the phone as it is a lot of information to go over.

I will try to put some info here.

I have many clients that do 1031 exchanges out of CA to buy triple net properties. Typically they have had a big run up on equity and might be getting just a 2 to 3% return. They want to 1031 and go passive with retail and put more of that equity to work. For single tenant net lease the type of tenant available and market cap rates can vary by state and then location (rural, weak suburban, strong suburban, urban core). Unless the investor is local and lives there most of my clients stick to buying in urban core to strong suburban areas.

For tenant type you have credit rated investment grade tenants BBB- or better by Standard and Poor's. Parent corporate guarantee tends to be the strongest and most secure from a  credit standpoint although any tenant can go dark but odds tend to be smaller percentage wise the better the credit rating.

For tenant risk I have my 5 levels.

Strongest to weakest usually:

Investment grade credit parent corporate guarantee.

Subsidiary of investment grade credit.

Large franchisee typically 50 units or greater and long time operator

Small franchisee with one to maybe a few units

No investment grade corporate credit or even a franchisee but a local mom and pop operation. 

STNL 3 million and below about 75% are all cash purchases and maybe 25% financed. 4 to 6 million and up about 75% financed and 25% cash ( the investors even with all cash generally do not like putting into one single property that high of a concentration of cash).

So for example depending on your 1031 proceeds for your first exchange and whether you will add more funds to that can depend on what type of property you can afford. If you had 3 exchanges with say 600k each and you didn't want to put more money into each deal then cap rate would be lower and properties sell much faster and are competing against all cash offers. Type of tenant also more limited to choose from and location.

If your 1031 proceeds each time are 1 million or more then as an example you could look at properties in the 3 million range versus 2 million which can make a big difference as to what is available for location,cap rates, and tenant type. The larger you go up in price the smaller the buyer pool shrinks so can get a little better cap rate and also better loan terms ( more lenders compete for larger loans as it is less to keep track of for servicing volume and locations tend to be stronger for higher priced properties.)

My clients sign exclusives with me because it is a considerable time investment on both sides to work to achieve the common goal of effectively finding the best property in the buyers range to purchase that meets their quality and cash on cash objectives.

The STNL market is fluid and the good properties go fast ( typically in days to 1 week max). Often developers and listing brokerages do not like dealing with new buyers unfamiliar with the process as they tend to believe there will be a high chance of failure if choosing that offer or going to contract. They usually want a buyer broker on the other end guiding the buyer through the process and knowing things are handled properly. The developers are busy building projects and the listing brokers are busy going out to add more inventory and represent more sellers.  With your 1031 exchange a seller will want to know at what STAGE you are at in the process ( List your property for sale, your property is under contract, your property is under contract and due diligence has passed and earnest money has gone non-refundable from your buyer, your property has closed and you are in 45 day ID period already.) Sellers like the last 2 as chances of you having the money to buy are high. The first 2 with one you do not have your property under contract yet and the other the property is under contract but your buyer can still back out of the deal and doesn't have a bunch of non-refundable money they could lose (skin in the game). Sellers have to asses odds when choosing a buyer (do they have a good broker and support system, do they have the funds ready to go, is their proposed loan terms reasonable for the market are they trying a hair brained loan that has a little chance of happening?)

With pharmacies Walgreens almost always have flat rent in the primary period. Some DO have rental increases in the options but more rare. CVS tends to have more rental increases in the option periods but also in the primary term can have rental holidays at the end of the primary lease term with no money coming in (in those cases a rent credit can be given in advance but it can affect financing so have to plan in advance to set up properly with the purchase). A sweet spot can be a Rite Aid with a vintage lease in a good location that Walgreens purchased. With that you might land a slightly higher cap rate with rental increases in the option periods with Walgreens backing the lease. With Rite Aid stand alone  without Walgreens credit they are harder to finance with good terms.

For rental increases Davita or Fresnuis can be good with starting cap rates in the 6's. Most buyers do not hold for more than 5 to 10 years.

I often find the sweet spot is how many years are remaining on the primary term.

Example a newly minted lease of 15 years Davita going for as an example a 5.75 to 6.0 cap rate. The developer usually has legal fees, real estate commissions, short term capital gains and has made little to no cash flow off of the property so wants the lowest cap rate possible.

Conversely a property with say 5 years left on primary is very hard to get a decent loan. There is not enough time for a lender to get comfortable with paydown of the note typically unless a very small loan and a shorter amortization period. Those might sell for in the 7's for cap rate.

The sweet spot is often 8 to 12 years remaining. Here the developer has made some cash flow over the years and is looking at long term capital gains versus short if they do not want to 1031 exchange. They are generally more reasonable on cap rate in the mid to high 6's and then debt as an example currently at about 3.9% fixed  for 7 to 10 years with a 25 to 30 year amortization schedule.

Triple net can be passive and easy to own BUT there is a lot of analysis that goes into selecting the best properties. You can lose money in NNN just like any asset class if tenant is bad, location is poor, lease terms are not optimal, guarantee on lease is weak. Even with a great location sometimes access is bad. Sightlines are not good as property sits in a hole or high on a hill, etc. Parcel layout can also be bad and not have enough parking spaces for the business model.

I understand why you want to get passive. I sold larger apartment buildings before getting into retail over a decade ago. I still do multifamily for bigger properties with larger clients (tens of millions in price and up) but mainly do retail these days. Retail is typically the last stop on the investment train to retirement for many investors. They have a progression based on starting small in early ages with SFR, then smaller multifamily, then larger multifamily or office, then to retail (less headache, more passive). I have some clients that do not have to go that route as they own a business making tons of cash, sold a business, are a high income earner in the tech space, or a doctor, etc. They can usually skip all that other type of investing because they have larger capital to move to commercial right away.

Hope it helps. I can talk about this stuff for months so ask away with your specific questions and I will try to answer.