The ups and downs of a single tenant NNN Lease property

[John McKee]

Bought a property in 2005 that was an absolute NNN corporate restaurant lease. For 11years they paid rent like clock work, then one day they shut their doors and did not fulfill the rest of their 15 year corporate term. They had 4 years left and decided to give me only 1 year of rent on the remaining term in their shakedown negotiating. It took 1.5 years to find the right restaurant tenant (franchisee). I chalk it up to the Lazy brokers that took the listing. Tenant struggled a bit and then covid hit. Tenant could not pay taxes and had to give him a break on rent. I was on the hook for the roof and some other structural repairs now that I owned the building. My IRR was starting to see some cracks and further rent reductions were needed to keep the tenant running. Luckily I knew the land was valuable, but I had to hang on. I just didn't have the time to do the work which was to redevelop the property. I had to come out of retirement recently to put some work into stabalizing this property so I started dialing like a hungry broker to find a deal. I finally landed a deal with a Major Restaurant group with strong sales and negotiated an absolute NNN lease for more rent for the next 10 years. The downside is that I have to put in $480,000 Dollars of TI and brokerage fees, but the upside is that they will be putting in 1.5 million to redesign and improve the existing structure. 10 years from now I might have to go through the same thing, but I wanted to give you an example of how things can go wrong at the end of these leases.

[Ronald Rohde]

How much did you float out of pocket until you signed the new lease? Are you doing the TI cash or as part of a refinance/second with your lender?

[Ronald Rohde]

Thanks for sharing, the bad along with the good, I mean trouble free rent for 11 years!!

[John McKee]

TI is paid at time of opening which is 6 months from now.  Money will come from savings.

[Aditya S.]

The reliance on brokers for filling tenant spots in commercial always worried me. Just due to supply/demand (there are always more people looking for homes vs businesses/retail looking for space), how much a lazy broker can make or break you in commercial stands out.

Glad things are starting to look up for your property.

[Michael K Gallagher]

@John McKee thanks for sharing this story, there are certainly ups and downs, glad you got something figured out and moving forward.  

@Aditya S. I do a pretty good amount of retail deals around the country, and just like in residential "free space in the dessert, is still free space in the dessert" meaning that while it may appear there is less demand in the business/retail world, its all down to where your retail space is.  Something tucked in the corner of a shopping center, or outside of an anchored center in going to be harder to fill, just like rentals in a crap area, that hasn't been redone in 15 years is harder to fill.  Don't get me wrong there are plenty of lazy retail brokers out there, I run into a bunch of them every day, but the vast majority of locations I see sitting for along time are simply less than desirable because of the visibility, ingress and egress, or something else all together.  Not trying to imply at all that this was the case with John's property, just trying to illustrate that while yes there are plenty of lazy brokers, in retail, like in residential, location is still everything as far as demand.

[John McKee]

I understand that most brokers are busy and will only give you a limited amount of their time.  That comes with the territory as they have hundreds of clients.  In my case I had a class A location and it took the initial broker almost 4 weeks to put up a sign.  I think it's key to hold brokers accountable via certain milestones.  Example:  Listing on line within 2 days, a professional sign within a week (the kind you dig holes in the ground for), an updated list of contacts they have reached out to.  Maybe a status meeting once a week.  Remember this is a business to me and not just a listing.  Time is money and having to wait for a broker to ramp up their marketing process is costly to the landlord.  

[Ronald Rohde]

Quote from @John McKee:

I understand that most brokers are busy and will only give you a limited amount of their time.  That comes with the territory as they have hundreds of clients.  In my case I had a class A location and it took the initial broker almost 4 weeks to put up a sign.  I think it's key to hold brokers accountable via certain milestones.  Example:  Listing on line within 2 days, a professional sign within a week (the kind you dig holes in the ground for), an updated list of contacts they have reached out to.  Maybe a status meeting once a week.  Remember this is a business to me and not just a listing.  Time is money and having to wait for a broker to ramp up their marketing process is costly to the landlord.  

 Agreed, I have some lazy brokers right now. (busy, but not making our listings a priority)

[Joel Owens]

Yeah we own many properties and some leasing brokers are good and some are lazy.

I would challenge the (A) location taking 1.5 years to fill. If it's an (A) location you do not need 1.5 years especially to land a franchisee restaurant tenant.

When I look at a property I look at the current value, the dark value, and the re-potential value.

Lot of commercial developers sell off marginal tenants at market rents.

Example me buying a Wal-mart with 10 plus years left at a 7 cap is way different than trampoline or workout place at a 9 cap.

On its face the 9 cap may be appealing but then you find out for that box size the crap tenant is paying 1 dollar below what national tenants pay. That weaker tenant agrees to anything just to get in a space. The property is then sold off to a sucker. The tenant goes dark and now you have to back fill it with 500k to millions in cost. Guess what since previous weak tenant was market rent you are losing your ***.

I look at high cap stuff when it's few years left ( blend and extend ) or it can be weaker tenant at higher cap rate like 10 cap BUT I want them paying about half the going market rent for the building size or less in that market. That way I win both ways. If they stay and pay I get an ultra high return. If they go out I can raise rents to still below market a little for a good deal to a tenant but after my lease up expenses still have additional equity and value to show for it.

I shake my head at buyers buying Popeyes with some small franchisee that is 6.2 cap rate versus national grade credit at 5.9 cap and that Popeyes paying market rent. Those developers pray long enough while building out the building that the tenant will open and they can sell it off before taking a bath on it.

The small to medium franchisees eventually if the have trouble get bought out by a Private Equity group that runs them like sh*t and makes their money back and sucks any remaining profit dry before they close or ask landlord for rent reduction.

That's what 20 years experience teaches you versus buyers just looking at a cap rate thinking something is a good deal. You could look at a 20 cap (being funny) but if the 10 year lease they go out in year 2 it didn't mean squat.

We are taking down investment grade tenants all cash with my core plus syndication 200k minimum per investor. Works out to be about a 6% cash on cash return to LP's which they love. Multifamily syndicators many pausing distributions so investors getting hosed on those for years and now they seek safety.

What's awesome about investment credit grade tenant is what you model out is typically what you get. Multifamily you can win big or lose your *** it's all about if you already made your money with your career, business, investments already and want to be safer.

Right now owning NNN yourself without a syndicate is tougher especially in the smaller 4 million and below price ranges. The reason is a 5 cap might have risen to a 6 cap but the debt still at 7 s underwater on spread. That makes down payment of 30% when cap rates 5 and interest rates 3.5 now 45% down with huge interest payment to make DSCR work with lender and only get cash on cash of about 3.5% and buyers say that suck I get 5 in the bank no thanks.

Now in bank they get highly taxed on the 5 and some banks unstable right now depending on who they hold funds with. You could say they are FDIC insured to an extent but claims to be made whole on a failed bank to get reimbursed by the FEDS can take a very long time in some cases.

The NNN even if return was 5% you have hopefully property appreciation value long term, tax depreciation against the asset, rental increases, etc. you do not get with the bank.

So my clients unless they are buying say a 6 million and up single tenant where I can land 7 plus cap rate above the debt a little those smaller deals sub 4 million do not work unless they are paying all cash or have a tiny loan like 25% LTV so the high interest rate does not affect cash flow that much.

So what if someone HAS TO buy with 1031 for large taxes. Usually we get loan with little to no pre-pay penalty and maybe they hit 4.5% cash on cash return going in and then when hopefully rates drop in a year or two they can refi and push cash on cash to 6 to 8% while being passive.   

[John McKee]

The other thing I will mention is that it is difficult to replace a Class A tenant that is a large space.  Your selection becomes limited due to the size, so I like to caution my fellow investors that sometimes smaller can be better.  A lot of it's timing in the market, nearby competition, and knowing who is actually looking to expand.  In addition the Tenant may require 6 months of a ramp up/build out period before paying rent.  

[Adam M.]

Quote from @Ronald Rohde:

Quote from @John McKee:

I understand that most brokers are busy and will only give you a limited amount of their time.  That comes with the territory as they have hundreds of clients.  In my case I had a class A location and it took the initial broker almost 4 weeks to put up a sign.  I think it's key to hold brokers accountable via certain milestones.  Example:  Listing on line within 2 days, a professional sign within a week (the kind you dig holes in the ground for), an updated list of contacts they have reached out to.  Maybe a status meeting once a week.  Remember this is a business to me and not just a listing.  Time is money and having to wait for a broker to ramp up their marketing process is costly to the landlord.  

 Agreed, I have some lazy brokers right now. (busy, but not making our listings a priority)

@Ronald Rohde I can personally (DFW) relate to this on a deep and meaningful level!

[Ronald Rohde]

Quote from @Adam M.:

Quote from @Ronald Rohde:

Quote from @John McKee:

I understand that most brokers are busy and will only give you a limited amount of their time.  That comes with the territory as they have hundreds of clients.  In my case I had a class A location and it took the initial broker almost 4 weeks to put up a sign.  I think it's key to hold brokers accountable via certain milestones.  Example:  Listing on line within 2 days, a professional sign within a week (the kind you dig holes in the ground for), an updated list of contacts they have reached out to.  Maybe a status meeting once a week.  Remember this is a business to me and not just a listing.  Time is money and having to wait for a broker to ramp up their marketing process is costly to the landlord.  

 Agreed, I have some lazy brokers right now. (busy, but not making our listings a priority)

@Ronald Rohde I can personally (DFW) relate to this on a deep and meaningful level!

 Are you using big brokers or regional? I couldn't see any assets on your website, what stuff do you hold?

[Adam M.]

Quote from @Ronald Rohde:

Quote from @Adam M.:

Quote from @Ronald Rohde:

Quote from @John McKee:

I understand that most brokers are busy and will only give you a limited amount of their time.  That comes with the territory as they have hundreds of clients.  In my case I had a class A location and it took the initial broker almost 4 weeks to put up a sign.  I think it's key to hold brokers accountable via certain milestones.  Example:  Listing on line within 2 days, a professional sign within a week (the kind you dig holes in the ground for), an updated list of contacts they have reached out to.  Maybe a status meeting once a week.  Remember this is a business to me and not just a listing.  Time is money and having to wait for a broker to ramp up their marketing process is costly to the landlord.  

 Agreed, I have some lazy brokers right now. (busy, but not making our listings a priority)

@Ronald Rohde I can personally (DFW) relate to this on a deep and meaningful level!

 Are you using big brokers or regional? I couldn't see any assets on your website, what stuff do you hold?

Mix of both-- we have portfolio in West Texas (at the moment comprised mostly of 1-4 unit properties) but are looking to expand into DFW multifamily now. What about yourself? 

[Ronald Rohde]

Quote from @Adam M.:

Quote from @Ronald Rohde:

Quote from @Adam M.:

Quote from @Ronald Rohde:

Quote from @John McKee:

I understand that most brokers are busy and will only give you a limited amount of their time.  That comes with the territory as they have hundreds of clients.  In my case I had a class A location and it took the initial broker almost 4 weeks to put up a sign.  I think it's key to hold brokers accountable via certain milestones.  Example:  Listing on line within 2 days, a professional sign within a week (the kind you dig holes in the ground for), an updated list of contacts they have reached out to.  Maybe a status meeting once a week.  Remember this is a business to me and not just a listing.  Time is money and having to wait for a broker to ramp up their marketing process is costly to the landlord.  

 Agreed, I have some lazy brokers right now. (busy, but not making our listings a priority)

@Ronald Rohde I can personally (DFW) relate to this on a deep and meaningful level!

 Are you using big brokers or regional? I couldn't see any assets on your website, what stuff do you hold?

Mix of both-- we have portfolio in West Texas (at the moment comprised mostly of 1-4 unit properties) but are looking to expand into DFW multifamily now. What about yourself? 

Just industrial, 5 properties, about 140k sq ft and 14 acres of IOS. All NNN leased, unless truck parking.

[John McKee]

One other negative that people don't think about is that even if the tenant is doing well, sometimes at the end of their lease they will try to squeeze you for more TI to remodel the place in exchange for a lease renewal. This makes the absolute NNN no longer so!

[Gabriel Graumann]

@John McKee having assisted investors find single-tenant, absolute net lease product for years, this story has been experienced by many others for sure. The LL's I've seen come out the best are the ones who have the best leverage and willingness to "fight" (or spend the money to fight) the big brand when necessary. Strong location wins nearly every time, especially in supply constrained markets. A hot corner property with a drive-thru with adjacent huge traffic counts doesn't sit empty. When a tenant goes dark, the space easily fills. Yes, there may be TI's required that weren't counted on, but the strongest locations often are where the fewest TI's (paid by LL) are necessary, or the fewest concessions are given. Big brands want the traffic flow and market share. My experience is that the smaller market towns and non-prime locations are the ones more often that run into the scenario you unfortunately did. I sympathize with you for sure, the scenarios is painful. I would ask though how strong of a location it was for it to stay dark for 1.5 years. Either the market was saturated already, was a smaller market community, or both. I've yet to find a major metro, corner location, with a drive-thru (including covid year), go dark and stay dark for 6+ months.

Not in 20+ years of retail investing. What most often happens is that investors don't like the lower cap rates that prime corners provide, so they stretch their risk parameters to include similar properties but in weaker markets to get them the extra 1-2% increase on the cap rate. The short-term reward of higher cashflow can be negated when the crap hits the fan like you shared, and years of profit are lost. Just a thought from a different perspective. 

[John McKee]

The location is strong, but the market was Saturated (something I didn't realize at the time).  The Market was a second tier city, but had the traffic and demographics to support any Chain however some of the National Chains don't understand the nuances of a local market.  Most of the blame is put on the Broker's however for not being aggressive enough and reaching out of their own networks.  When a broker brags about some large deal they did a few years ago, I now know it's time to find another broker.  In a saturated market everyone barely survives so what I have learned is that you have to bring something new and different.  I never chase cap rates (I.E. Dollar stores) as I always focus on the dirt.  

[Joel Owens]

Just another tidbit for you folks. We own NNN properties. In smaller suburban markets what you often get from national brands is ( We like the corner location but do not want to run a parent corporate store from there or we do not have a franchisee in that area yet or we would put a store there.)

Often in smaller suburban markets it is established brands with multiple locations that are regional that covet the corners. Sometimes if a small suburban market is exploding with growth turning into a strong suburban market than lots of brands want the corner. All corners are not created equal either. A corner with the Wal-mart is much more sought after than say a corner across the street that has a furniture store as the main large tenant traffic draw. These minor details make big differences in great success with a property and mediocre. These nuances come with time, knowledge, and experience deal to deal.