What is Triple Net Leased (NNN) Real Estate?
Triple Net Leased real estate can be everything from a Walgreen Drug Store to a dollar store such as Family Dollar and Dollar General. Other net lease properties include bank building such as Bank of America, food such as McDonalds, Burger King or Taco Bell or auto service and part stores like Bridgestone/Firestone or an Advance Auto. Also included are FedEx distribution centers.
Net lease properties are typically free standing buildings that are leased to tenants for a 10 to 25 year term. They offer the benefit of little or no management responsibilities as the tenant pays for all, if not most of the expenses. The investor receives their rent with little to no other involvement.
Who Buys Triple Net Leased Properties?
Investors who wish to have outright ownership of their investments. The alternative would be to own a security in the form of a mutual fund or REIT. A major advantage of 100% direct ownership is control and the ability to defer future capital gains by doing a 1031 exchange when the property is sold. The lack of immediate liquidity that a mutual fund or REIT can offer can be a drawback for some investors and should be considered carefully before investing.
How are Triple Net Leased Properties Valued?
Net lease properties typically are valued using their Capitalization Rate also referred to as Cap Rate. The cap rate reflects the value of a stream of economic benefits discounted for time and risk. Generally this is computed by as a pretax cap rate using the Net Operating Income (NOI). NOI is income less all expenses before debt service. The Cap Rate is the NOI divided by the purchase price. Conversely the NOI divided by the Cap Rate will equal the purchase or selling price.
NOI = $100,000/10% = $1,000,000 Purchase or Selling Price
NOI = $100,000/$1,000,000=10% Cap Rate
How is a Cap Rate Determined?
Some of the major considerations are:
- The credit worthiness of the tenant (see Tenant Credit Rating
under Resources on upper right)
- The length of the lease, typically 10 to 25 years.
- The type of lease, triple net (NNN) or double net (NN). See below for definition.
- Type bumps or increases if any.
- Cost of financing
- Strength of the demographics of the property location
- Nature of the improvements. Are the improvements easily converted for another tenant or are they special purpose that would require significant expense and time to convert before re tenanting?
- Age and condition of the improvements
The more positive the above factors, the lower the Cap Rate or the higher the value of the property related to its income stream. Conversely if the above factors are weak the Cap Rate will be higher and the resulting value will be lower reflecting the greater risk of the investment.
It is important to remember that markets are not perfect and a low Cap Rate does not necessary mean a lower risk property, it could simply be a bad investment that is over priced. Astute investors seek properties that are mispriced in their favor, namely a higher Cap Rate for a property that has lower risk factors.
Types Net Lease
Most net lease investments are either triple net (NNN) or double net (NN). Below are more refined definitions of varies forms of net lease properties.
Absolute Triple Net (NNN)
The tenant pays operating expenses such as maintenance, repairs, taxes and replacement for the entire property, without limitation. The owners pay the mortgage only. This is the type of lease that most investors expect when purchasing a triple net lease (NNN lease).
Bond Lease (NNN)
A slight variation on the NNN (Triple Net) lease, a Bond Lease requires the tenant to absolutely comply with their rent and operating expense obligations regardless of extenuating circumstances affecting the property (i.e. Even if the property is under eminent domain proceedings)
Double Net Lease (NN)
Similar to a triple net lease (NNN lease) but with additional owner responsibilities. The owner is generally liable for the structural components of the building such as the roof, foundation, load-bearing walls and parking. Leases will vary so they should be carefully read.
Net Lease Alternative
For investors who would like to invest less capital but still have little to no management responsibilities Tenant in Common (TIC) is a good option to consider. Advantages of TICs are the lower minimum investment (starting at $50,000); prepackaged financing and due diligence material. Because TICs require less cash smaller investor can
more readily achieve diversification to reduce risk. CLICK HERE for more information on Tenant in Common investments.