NNN property a long term development play?

[Phil B.]

I own a few multifamily rentals and have been exploring single tenant NNN opportunities. Does anyone who buys these look at the long term conversion or development of the property in the event the tenant doesn't renew after the lease term?

That seems to be the biggest downside. I have looked at a few dollar general deals in the 1-2MM range with 10 years left on the lease term. It would be a very expensive piece of real estate to own if you couldn’t re-lease or develop.

[Joel Owens]

Hi Phil,

I review about 1,000 NNN properties a week. It's all I do pretty much.

Typically weak suburban to rural areas are last to recover in economic cycles and first to fall. For these reasons unless an investor is local to the asset I like my clients to own in strong suburban to urban core areas preferably in a warm belt state where population are growing heavily with net migration away from the cold belt states.

Cold belt states prices tend to be less and cap rates a little higher but many areas are declining. Long term dirt value is not that good in declining areas and tenants with expansion plans often do not want to open up in these areas. So what happens as population levels go down more of the national to regional tenants exit for greener pastures and then you are left with mom and pop tenants who can pay much less rent per sq ft to make the business viable and profitable. 

There are still some very nice areas in cold belt states but more smaller concentrated ring radius whereas warm belt tends to be more all over with just a few areas not good.

Dollar Generals I am not that great of a fan. 1 million property in commercial is like a 100k house. Very rare if ever to find anything good in that range. Things open up considerably at 2 million and more so at 3 million. Typical with an investment grade tenant is 30% down so 2 to 3 million price point looking 600k to 900k down plus about 40k to 60k in closing costs. 

Dollar Generals many years ago before they thought they were big stuff had rental increases in the primary lease term. Now it's 10 to 15 years of flat rent. The buildings are often in weak suburban to rural locations and on well systems with septic instead of sewer. The buildings are mostly sheet metal sides and back and not well located. Building has little value when dark due to poor location and construction quality has most tenants passing on the building to release up.

About 15% of Dollar Generals are upgraded construction in strong suburban core areas. Those tend to be lower cap rates and get multiple offers as the land value can be worth more.

I like strong suburban to urban core areas because only so much can be built as the population grows over time. Good pieces of land get harder to find so some build on top of existing buildings or scrape and build new. Counties and cities often relax zoning and density laws further and so dirt and air rights tend to become more valuable over time.

If you have a vacant building on releasing the rent per sq ft you need is often lower than what a developer has to buy the land for and build ground up with building materials, labor, and legal fees.

Why do people buy Dollar Generals then? Because typically one of the main investment grade tenants under 2 million where cap rate is a little higher and you still can get good debt. Problem is location is junk and so is the building quality in most cases.

There are other options in the 2 million range I like better like an Aspen Dental with 10 year primary term lease in a strong suburban core area and 10% rental increase every 5 years.

To comment further I really have to talk to potential clients and see what their goals are to make possible suggestions.

Hope it helps.