Commercial real estate investors are continuing to step beyond the four basic property types – apartments, office, industrial and retail. One sector that is attracting attention – and more capital – is single tenant net lease. In fact, the net lease investment sales market now generates more than $60 billion in annual transactions. So, what exactly is net lease?
Net lease is a unique category within real estate where properties are typically backed with a long-term triple net (NNN) lease. In a NNN lease, the tenant pays for the rent and other big expense items – insurance, utilities and maintenance costs. The only financial responsibility for the landlord would be covering any debt service if there is a loan on the property. The vast majority of NNN assets are leased to a single tenant. NNN leases have become standard practice for a wide variety of corporations such as Chic fil A, 7-Eleven, Walgreen’s, Home Depot and even Amazon.
Credit is king
As with any real estate investment, factors such as location, age and condition of the property drive value and pricing. However, it is the lease and the tenant backing that lease that steals the spotlight and drives pricing in the net lease investment market. The lease is a contractual agreement to pay rent that effectively acts much like a corporate bond. As such, the credit of the tenant signing that lease, as well as the amount of term on the lease, play a critical role in influencing property pricing and cap rates on net lease assets. The most sought-after “A” rated tenants, such as McDonald’s, Starbucks, and FedEx command premium prices. Likewise, investors will pay more for a net lease investment property that has a longer term lease in place, such as 15+ years, as compared to a property that has less term remaining. Shorter term leases, such as 5 years or less, are viewed as inherently riskier as the tenant could decide they no longer want or need that particular location.
One of the interesting aspects of net lease is that it spans many different property types. Investors who buy net lease properties can shop a wide range of industrial, office, retail, restaurants and other commercial facilities. Even government facilities occupy net lease assets with leases that are guaranteed by the General Services Administration (GSA). Net lease properties also cover a wide spectrum of price points starting at less than $1 million to more $35 million, which makes NNN assets very accessible even for small investors.
Key Benefits of NNN investments
Passive investments: One of the biggest advantages of NNN investments is that they are generally considered to be “passive” investments. Because of the NNN lease structure, the tenant is responsible for day-to-day maintenance and upkeep, such as fixing a leaky faucet, hiring a landscaping crew and making sure bills are paid on time.
Steady, fixed income: NNN investments are known for generating steady, predictable income for investors. The rents are locked in at fixed rates, usually with long-term leases that have built-in rent escalations over time. There is no need to budget for upkeep or “surprise” repair costs that can impact income. That steady income is why investors often view NNN as a buy and hold strategy. There also is the added opportunity to realize property appreciation over time.
Low risk: NNN properties are often viewed as low-risk investments because they are backed by long-term lease agreements. That being said, investors can move the lever on risk-adjusted returns by taking on more or less risk. For example, an investor who is comfortable taking on more risk with a lower credit or non-rated tenant and/or a short-term lease is usually rewarded with a more favorable purchase price.
Tax benefits: Investors get the same tax benefits from owning net lease assets as with other types of commercial real estate, such as depreciation and a step up in basis when passing assets on to heirs.
If you’re new to net lease real estate investments and would like more information, contact us today! Our experienced brokers are here to help.