Commercial Real Estate

Analysis of a Triple Net (NNN) Deal: Is This KFC Building a Good Investment?

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Do you ever think something sounds like a great investment deal? Is it possible it’s really not? Aside from more complicated factors like market fundamentals or rent sustainability, is it ever possible the numbers themselves can trick you?

Yes!

I've recently been exploring commercial investment deals. For anyone who knows me, you know I'm not usually into commercial. But I've been consulting with someone to find something in the $1.5M-$2M range, and the journey has been very eye-opening. We first met with a commercial agent to explore the options. We discussed restaurant buildings, retail buildings, multifamily residences (5+ units), and we even threw out high-dollar residential buildings.

It was very quickly obvious that a $2M residential property in Venice Beach would not cash flow. There was no question there, as the cap rate wouldn’t even pretend to be positive. So we started ruling out the entire notion of the residential property idea.

The most exciting option seemed to be a NNN commercial building. This would be buying a building that a commercial tenant would rent out. For example, a McDonald’s. McDonald’s themselves don’t own the buildings they are in, as most businesses don’t, and that building by itself would be something we could buy. Then the NNN (called “triple net”) part is that unlike owning a residential rental property where you (the owner) has to pay for the repairs on the building, the tenant pays for everything. So you buy the building and never have to pay expenses for the building—McDonald’s would pay it all.

There are different versions of NNN options—some mean the owner pays absolutely nothing, some mean the owner has to pay for the roof and structure but nothing else, and whatever other variant there might be.

The other factor we were encouraged to consider was buying a NNN in another state outside of California. The reason for is that the land in California is more expensive than other places, so there would be a higher return if we were paying a lower price for the property initially. Make sense?

The KFC Deal

So we began exploring NNN options. We looked at a KFC (Kentucky Fried Chicken), a Starbucks (yum!), a Verizon Wireless store, and there was even a three-tenant building that had a Chase Bank, a T-Mobile store, and a Mexican restaurant called Filberto’s. I personally liked the latter the best, but it had just sold to another investor. All of these properties were outside of California.

I’m going to give you the best deal of them all to explore in more detail—the KFC.

free-mentor

This KFC is in Nebraska and priced at $1,477,000. It was the best of all of the options presented with because the cap rate was higher than the rest (6.5%), the lease term of the tenant (KFC) was the longest (a new 20-year lease), and the tenant was responsible for everything including the roof and structure. It is also sandwiched between some major high-dollar companies like a new Walmart and many others.

The other properties all had lower cap rates, maximum 10-year leases with the option to get out early, and the owner (us) would be responsible for the roof and structure.

No contest, the KFC was the front-runner.

Very simply, here are the numbers associated with this property. And remember, this is literally the most hands-off real property you can buy. The most you could do with this property if you own it would be to walk in and order a bucket of chicken. So that alone is pretty enticing—no work! Not even if you wanted to work on it!

Purchase Price: $1,477,000

Annual Rent Collected: $96,000

Cap Rate: [(96,000/1,477,000)*100] = 6.5%

Wow, what’s not to love about this investment! Sure, 6.5% isn’t an insanely high cap rate, but it’s very solid, totally decent, and you’re literally hands-off and stress-free with this property. Some markets like Atlanta and Houston offer 6.5% cap rates on their residential rental properties, but you still have mangy tenants and/or property managers to deal with and headaches with repairs and such. Additionally, there are many commercial deals out there at a standard 7.5% cap rate, but they all require more of your participation and offer more headaches. So 6.5% with no effort? How could you beat that?

Related: BP Podcast 047: Apartment Complexes, NNN Leases, and Commercial Real Estate with Joel Owens

Is it REALLY a Good Deal?

Sounds like a killer deal, right? Actually sit back and think about it and decide whether it’s a good deal or not.

Initially, we thought this may be the perfect investment for what my client was looking for. Granted, he was semi-morally opposed to KFC just because he loathes fast food, but who cares who the tenant in a property like this is if they are solid and going to be paying? It’s not like he’d have to go in there and eat the chicken.

OK, so you’ve thought about this deal. Are you on board with it? Do you think it’s solid? Is there anything we’re missing that would be important to consider?

Obviously, there is probably something missing since I’m asking. What is it?

What if you are financing rather than paying cash?

Plenty of people do have $1.5M to drop on an investment, but a lot don’t. The particular client I’m working with doesn’t and plans to finance an investment property.

Does this matter?

It's very tempting when you see a deal that is presented to you and everything looks good about it to just go with that and not do further investigation. The agent says it's a killer deal, it looks and feels like a killer deal, and why wouldn't it be? It all seems legit.

There is one piece of information that is not included in the marketing packet for this KFC building—the financing.

A Note About Cap Rates and Cash-on-Cash Returns

Before we go any further, you absolutely need to be up on the difference between cap rates and cash-on-cash (CoC) returns. If you are even remotely questioning your knowledge of these two terms, pause with this article for a second and go read “Cap Rate and Cash-on-Cash Return: A Definitive Guide.”

Be sure you are up on the details of what goes into each, but here’s a very short blip about the two. Cap rate only measures the purchase price of a property as compared to how much income it brings in. The CoC is the actual return that you are getting on the money you put into that investment.

If you pay all cash for an investment property, then the CoC will be the same as the Cap Rate. If you are financing, however, it will be different. If you are financing, the more accurate number you need to know when evaluating a potential investment property is the CoC because that tells you exactly how much bang you are getting for your buck.

When you calculate the CoC, the number will be different because instead of comparing the net income with no financing cost included with the purchase price, you will be comparing the net income with the financing cost included to how much money you actually put into the deal. So you end up with an actual percentage return on exactly how much return you are getting on the amount of money you put into the deal.

Cap rates are only helpful for buying and selling purposes—and only if you pay cash for the property. The reason it works to use it if you pay cash is because the numbers will be exactly the same for the CoC equation as they were for the cap rate equation (i.e. no financing differences).

If you are lost as to what I’m saying, go back and read the article. Or if it’s starting to make sense but you aren’t quite there yet, go to the article and refresh.

What Financing Does to the Deal

So now! Back to KFC.

We already said the cap rate on this property is 6.5%. Honestly, that’s not too bad for a NNN property! It’s pretty good actually.

But what happens if we finance it?

Here are my assumptions:

Purchase Price: $1,477,000

Down Payment (35%): $516,950

Loan Amount: $960,050

Annual Mortgage Payment (4.5%, 30-yr): $58,373.19

Net Income After Financing: [96,000-58,373.19] = $37,626.81

So now we know to expect $37,626.81 annually from the property after financing. Is that a good return on your half a million down? Let’s calculate it and find out. We already know the cap rate, so now we want the CoC with our new numbers.

CoC: [(37,626.81/516,950)*100] = 7.3%

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Well, I may be tempted to call this one a winner! A 7.3% Coc is higher than the 6.5% cap rate, so that’s encouraging, and a 7.3% return on my money seems decent. It may not be as high as some investment options, but for something I literally don’t have to stress over, it seems pretty good.

Were you thinking the CoC would turn out to be bad because of how I led you into it? I did that on purpose. I did it so that you would realize it is possible for a CoC to be lower than a cap rate! It all depends on the financing terms.

My client hasn't purchased a property yet to know for sure, but the rumor is the interest rate to expect will be about 4.5%. That seems low to me, but I trust my agent for now. But what if the interest rate was actually 8% (like I assumed it would be)? What does that do to the CoC return? Without spelling out the details of the numbers, but using a loan calculator to determine the loan payment, I come up with a 2.2% CoC. Eek! Just a change in interest rates makes a huge difference! A 2.2% CoC is horrible.

Now, here’s something else to consider and a good lesson in life—never trust anyone else’s numbers for any investment opportunity!

I initially sent all of the property options to my client and he ran the CoCs on all of them. I was driving one day when we got on the phone to discuss the properties and he let me know that all of them had minimal to no cash flow after financing. I thought, “well sheesh!” There went all of those properties out the window. It didn’t shock me they wouldn’t cash flow because oftentimes properties won’t with financing, so I didn’t think much of it. But because I was driving, I didn’t sit down and run all the numbers myself.

Related: Triple Net Lease Investing (NNN): The “No Toilet” Method to Real Estate Investing

Can you guess what happened with his numbers to make everything negative?

He was determined he wanted a 20-year loan and not a 30-year. He was quite adamant and just when I was sure I had convinced him to go with the 30-year, he slapped 20-year numbers into the CoC equations. Then, on top of that, he also thought 8% was more realistic, as did I, for interest. So what happens if suddenly you are using a 20-year loan with 8% interest? Well, without even calculating the CoC, I can tell you that it puts you at earning -$362.91 annually! So the CoC would be negative. You would be losing money on your property.

Maybe we can combine his extreme desire for a 20-year loan with the 4.5% interest rate and cash flow? Yep. It comes out to be a 4.5% CoC. Not overly high, but it is positive cash flow with a significantly shorter term, so it will be paid off sooner, and much less will be paid out in interest.

So there you have it, the results on the KFC property.

I don’t have a huge point in writing all of that other than to show you a real-life commercial property analysis. Whoa, it even feels weird to say “commercial” because I’m so used to residential rental properties!

Now, the last thing that would be more practice and may be insightful would be to run all of these scenarios on the other NNN properties we received. All of the cap rates on those were closer to 5.5% and the owner would be responsible for the roof and structure. I don’t even know what those expenses would range, but they would need to be taken into account to get accurate return projections.

What’s the verdict? Would you buy the KFC? How does it compare to other rental investment options you have explored?

Leave your comments below!

Ali Boone is a lifestyle entrepreneur, business consultant, and real estate investor. Ali left her corporate job as an Aerospace Engineer to follow her passion for being her own boss and creating true lifestyle design. She did this through real estate investing, using primarily creative financing to purchase five properties in her first 18 months of investing. Ali’s real estate portfolio started with pre-construction investments in Nicaragua and then moved towards turnkey rental properties in various markets throughout the U.S. With this success, she went on to create her company Hipster Investments, which focuses on turnkey rental properties and offers hands-on support for new investors and those going through the investing process. She’s written nearly 200 articles for BiggerPockets and has been featured in Fox Business, The Motley Fool, and Personal Real Estate Investor Magazine. She still owns her first turnkey rental properties and is a co-owner and the landlord of property local to her in Venice Beach.

    Randy E.
    Replied over 2 years ago
    Good article, Ali. I’ve signed NNN leases before. It’s not a completely hands off investment. The building owner collects all monies for taxes, insurance and maintenance items to ensure they are paid on time. All of these expenses are accounted for through a reconciliation process at the end of the year. Yes, the tenant pays for everything, but the building owner processes the payments and ensures the building is being maintained properly; there shouldn’t be much of a problem in this scenario w/a KFC. There are a multitude of things to be concerned with relative to this type of lease (e.g., early termination, viability of business, local markets, etc…), but they can be profitable over time. I signed a 10 cap deal in 2011 that is doing well today, but 6.5% would make me a little nervous.
    Andrew MacLeod from Charlotte, North Carolina
    Replied over 2 years ago
    Hey Randy! I agree that plenty of NNN leases have those features — landlord has to collect tenant’s proportionate share of common area operating costs and taxes, etc. — and the math (and management) can absolutely get more complicated. That said, there are tons of standalone NNN sites (think many Walgreens, built-to-suit dollar stores, etc) which are currently advertised around 7% cap rates and require nothing of landlord other than the ability to collect a cheque every month — I gather this is the market segment Ali is discussing. Another point here dovetails with Giovanni’s comment: note that this investor was adamant about needing a return based on twenty-year amortization — you probably noticed that this is the same period as the lease. When land is cheap and the economics of an area are not well-established, these buildings are not worth much without the original tenant, so amortization periods longer than the leases themselves become problematic.
    Randy E.
    Replied over 2 years ago
    Very true, Andrew. Thanks for the clarification.
    Randy E.
    Replied over 2 years ago
    Very true, Andrew. Thanks for the clarification.
    Randy E.
    Replied over 2 years ago
    Very true, Andrew. Thanks for the clarification.
    Giovanni Isaksen Investor from Bellingham, Washington
    Replied over 2 years ago
    Good piece Ali! A couple things that I’m sure you evaluated but didn’t mention when dealing with NNN properties: Who is the guarantor? The Corporation or the Franchisee? We typically pass on franchisee guarantors but even with a Corp we still review their financials and credit/bond ratings. Are there rent bumps in the lease? Even a 2% annual increase in rent can build up to a nice return over a 20yr term. Some NNN tenants don’t (including most Walgreen’s… but not all!) but typically there is something in there like a CPI bump. Like any other real estate deal it’s important to select a market with good economic and job growth. Granted no one has a crystal ball that sees accurately 20 years into the future but there may be a good reason why the cap rate on one property is higher one market than an other. If you’re looking for NNN I have a couple sources who specialize in it-
    Giovanni Isaksen Investor from Bellingham, Washington
    Replied over 2 years ago
    The last line should be “If you’re looking for NNN FINANCING…” Where’s that edit button!!!!
    Kris Patel Investor from Arroyo Grande, California
    Replied over 2 years ago
    In 2010 we could get 1.05% loan face, more Lian than PP. But will be negative cash flow. I wanted fix rate co- terminus with 25 yr lease on Walgreen’s. Cap was 7.35, fix rate 6.09, COC was about 5 % , happy for estate plan, nnn also. Saw property 3 yrs after purchase. In short need to put DN 17 % to get cock income in retirement, did 1031 X also.
    Kris Patel Investor from Arroyo Grande, California
    Replied over 2 years ago
    Meant loan 5% more than PP was available. DSCR of 1.05
    Claude S. Investor from Savannah, Georgia
    Replied over 2 years ago
    Where can I find NNN opportunities?
    Kris Patel Investor from Arroyo Grande, California
    Replied over 2 years ago
    In Wall St Journal on Wednesday, and check nnnproperties.com
    Joel Owens Commercial NNN Real Estate Broker & Syndicator from Canton, GA
    Replied over 2 years ago
    Claude you can try to search yourself or get with a competent commercial broker who specializes in NNN. I belong to ICSC ( International Council of Shopping Centers). It is the premiere organization for anything retail related. NNN you have single tenant free standing buildings and then multi tenant NNN building such as ( Starbucks, Aspen Dental, T-mobile) in one place. The website above is only one of thousands of sites across the country I have built in my database over 14 years in business. With ALI’s article it is clear that what many investors do not understand is FINANCING available for these types of properties and how to craft an offer. Financing kills deals. With NNN cap rate tend to be lower so DSCR numbers are tighter. You can’t buy an apartment for example and be off 40 basis points on the spread and go it still pencils let’s buy it. Do that with triple net and the whole dead can be dead and not happen. NNN is very interest rate sensitive for COC spreads.
    Joel Owens Commercial NNN Real Estate Broker & Syndicator from Canton, GA
    Replied over 2 years ago
    Do that with triple net and the whole (deal) can be dead and not happen. NNN is very interest rate sensitive for COC spreads.
    James Denon Investor from Westbrook, Connecticut
    Replied over 2 years ago
    I always wondered of these 20yr NNN leased property financing terms. I believe the loans are called in 10yrs and you need to refinance. So if the interest rate rose up to 9%, you will be cash flow negative on a 6CAP deal. Also, since the interest rates went up, your property is probably valued at 8CAP. So your property just depreciated significantly too.. so it is a double whammy. Class B- multifamily is more work but less prone to the long term interest rate risk. Yes if the interest rates go up your multifamily would also depreciate but you would the opportuinity to raise rents in an inflationary environment. So you would be cahs flow positive. On NNN, you are stuck and locked into that rent for a long time. Am I missing anything?
    Chris
    Replied over 2 years ago
    5, 7 or 10 year money is most common, amortized over 25; there are some fully amortized products out there though
    Chris
    Replied over 2 years ago
    5, 7 or 10 year money is most common, amortized over 25; there are some fully amortized products out there though
    Scott M. Investor from Atlanta, Georgia
    Replied over 2 years ago
    I would like to hear what happens to a QSR (fast food) building if the tenant ever leaves? I would assume most of the national brands like KFC, Burger King, Wendys, etc have very specific builds that others can’t use. Any examples or thoughts…..
    Chris
    Replied over 2 years ago
    1) Most QSR and fast casual chains do indeed have their own, relatively unique prototypes; I say relatively unique because most of the new prototypes are variations on the stylized box, and can be re-branded/built out to another retailers specs at a relatively low cost. 2) If the location warrants it and the brand wants to in a certain market they will scrape the lot/build to suit. 3) Mom & pop tenants often backfill old QSR buildings in lesser locations – they’ve got kitchens and drive through’s, often a cheaper build out for a restaurant operator than inline space.
    Chris
    Replied over 2 years ago
    1) Most QSR and fast casual chains do indeed have their own, relatively unique prototypes; I say relatively unique because most of the new prototypes are variations on the stylized box, and can be re-branded/built out to another retailers specs at a relatively low cost. 2) If the location warrants it and the brand wants to in a certain market they will scrape the lot/build to suit. 3) Mom & pop tenants often backfill old QSR buildings in lesser locations – they’ve got kitchens and drive through’s, often a cheaper build out for a restaurant operator than inline space.
    Greg Jeanfreau from New Orleans, Louisiana
    Replied over 2 years ago
    65% LTV seems a little conservative. Isn’t 70% or even 75% available?
    Kris Patel Investor from Arroyo Grande, California
    Replied over 2 years ago
    I have 25 yrs fix rate on Walgreen’s, no need to refinance.
    Jim Gardner from Louisville, Kentucky
    Replied over 2 years ago
    You forgot one thing. Possibility of KFC going belly up. I’m from Louisville KY and I tell you when KFC has a big promotion for Georgia Gold chicken it is time to bail on KFC.
    Rami W. Rental Property Investor from San Diego, CA
    Replied over 2 years ago
    Fun fact: McDonalds owns most their buildings for the most part. https://www.fool.com/investing/general/2016/03/06/mcdonalds-corporation-a-real-estate-empire-finance.aspx
    Aaron Cater Rental Property Investor from Fayetteville, AR
    Replied 4 months ago
    The first thing I noticed too. McDonald’s is one of the biggest landowners in the world.
    Richard Alvarez Investor from Vista, California
    Replied over 2 years ago
    Great analysis from everyone and a good article. I think when you start going over the numbers on the other investments, due to the clients need for 20 year financing, the returns will be exponentially less for them as well and KFC will still seem better. The investor will also need to understand the bottom line as well and the significance of the shorter financing term. Finally, part of the analysis needs to consider what a long term lease will do when the economy ebbs and flows downward in a recession compared to the potential loss in growth. The best time to start the long term lease is when pricing is at a historically high point, so when pricing falls your return will look great. Conversely, if the long term lease is done in a down time, after about three years of income and pricing growth you will be scratching your head wondering why you signed up for a long term lease at a set price and were not able to take advantage of the increased pricing. I have had to endure leases like this and though i was happy at the time of signing, three years later I was not realizing the significant gain. Back to completing the lease in a high period, because of a robust economy there is more competition for deals because there are more buyers. Therefore, the returns are lower that is great for sellers and bad for investors. Just a few other points to consider.
    Brian M
    Replied over 2 years ago
    Nobody has discussed the benefits of depreciation and how that can add to the value of the investment.
    Scott M. Investor from Atlanta, Georgia
    Replied over 2 years ago
    Or how much the value of the building is hit if KFC left?
    Randy E.
    Replied over 2 years ago
    Determining the health of a tenant’s business model and financial strength of his business is a critical aspect of evaluating these NNN leases. The higher rated NNN leases (Walgreens, CVS) have solid business models due to the aging demographics of the population and the fact they are well managed. Also, their buildings are not so identifiable as to limit other uses. However, fast food restaurants, like KFC, will require a little more thought in terms of exit strategy. It is incumbent on the building owner to go through a “de-identification” of the building to eliminate any unique features of the brand name. This could be a minor thing or something very costly depending on the unique features of the brand. The next step is to ask, “what other type business will be suited for this building,” and, “will the market support it”? The higher risk, lower rated NNN leases require a little more due diligence in this area, particularly when one considers potential buyers and/or tenants. There is a significant difference in selling to an end-user versus an investor. As you can see, the value of the building is impacted by a variety of factors.
    Chris
    Replied over 2 years ago
    Good advice to which I will add – evaluate location factors independent of the tenant. A 2008 construction, standalone CVS just went dark in my town – there’s a Rite-aid across town that was built in 2006 that is one of the top stores in the system, it has traded a couple times in recent years at lower and lower cap rates. The rite-aid benefits from less submarket competition and significantly better demographics relative to the CVS. A single tenant drug property is difficult to re-tenant – new construction CVS in secondary california markets are trading between 4-4.5% cap rates right now – at those prices you really ought to dig deep in to the demos/traffic counts/etc to ensure you’re not gonna have an albatross on your hands in 20-25 years. A fantastic location is your best hedge against vacancy risk. High traffic counts, lots of rooftops (housing) nearby, demographics in-line with retailer demand – these factors will ensure the long term viability of your single tenant investment.
    Chris
    Replied over 2 years ago
    Good advice to which I will add – evaluate location factors independent of the tenant. A 2008 construction, standalone CVS just went dark in my town – there’s a Rite-aid across town that was built in 2006 that is one of the top stores in the system, it has traded a couple times in recent years at lower and lower cap rates. The rite-aid benefits from less submarket competition and significantly better demographics relative to the CVS. A single tenant drug property is difficult to re-tenant – new construction CVS in secondary california markets are trading between 4-4.5% cap rates right now – at those prices you really ought to dig deep in to the demos/traffic counts/etc to ensure you’re not gonna have an albatross on your hands in 20-25 years. A fantastic location is your best hedge against vacancy risk. High traffic counts, lots of rooftops (housing) nearby, demographics in-line with retailer demand – these factors will ensure the long term viability of your single tenant investment.
    Robert Cramer
    Replied over 2 years ago
    I am a commercial broker in Texas. We deal in this arena every day. Financing plays a big part, as does the tenant. Single tenant can be great, multi-tenant is a better hedge against something negative happening. Lender’s prefer multi as well so most likely preferred rates over a Single tenant. Interest to see what happens over the next few years with interest rates and all the loans turning over.
    Chris
    Replied over 2 years ago
    This is all correct, but I feel it requires a disclaimer – in my opinion multi-tenant retail is absolutely NOT for inexperienced investors, unless it is stabilized and professionally managed. I can tell you many horror stories.
    Robert Creamer
    Replied over 2 years ago
    We ALWAYS recommend professional property management. We handle that as well, unless you have experience here I can only imagine the horror stories. We had to evict a pharmacy one time – pharmaceutical drugs have a entirely new eviction process. Always entertaining!!
    Genna Golden Rental Property Investor from Portland, OR
    Replied over 2 years ago
    I’m in contract for a single tenant NNN building. They want 4 10 year options to renew. (total of 40 years) so we are working into the lease that there is a 2.5% increase in rents every year, and that at each 10 year renewal period, the rent sets to market rate, followed again with the 2.5% rental increases for the following 9 years. Definitely have a lawyer look at the lease/work with the tenant.
    Chris
    Replied over 2 years ago
    Provisions that call for things like “market rate” at some point in the future can be a little dicey. Ambiguity is the enemy – the process by which “market rate” is determined ought to be definitively spelled out.
    Andy Gross from Baltimore, Maryland
    Replied over 2 years ago
    It seems like you could reap some significant tax advantages as well. Your interest is deductible, right? That and depreciation may make the entire property more financially appealing.
    Scott Schultz Rental Property Investor from West Bend, WI
    Replied over 2 years ago
    the other concern i always see with these deals, is you are relying on other big retailers to stay around, you may have a 2 year contract, but what is the buy out? if Walmart builds a new store and moves, you could be sunk, especially with leverage, and no your property is worth much less, carrying that empty property will eat you alive. for me the risk is too high, yea obviously if everything works as planned it could be fantastic however, one hiccup and you could be sunk, I would much rather have that $1.4MM in 25+ houses scattered all over and managing the risk as well as liquidity, but to each their own.
    Andrew Boulton Flipper from Los Angeles, California
    Replied over 2 years ago
    The company I work with invests in Single Tenant NNN investments nationwide, but on a significantly larger buy price ($10m-$75m). As noted, above by Giovanni, one thing that should ALWAYS be taken into account is the CREDIT of the Lease Guarantor. (If you come from Multifamily or apartment rentals, this is the credit score of your tenant). An example of Credit is if the KFC Franchisee only runs 2-3 stores, they aren’t may not be the strongest financially, especially when compared to a Franchisee with 15-20 stores. That SHOULD factor into your CAP rate / purchase price decision. (GIVE ME STARBUCKS CORPORATE GUARANTEE, OR McDONALDS ALL DAY AT A LOWER CAP RATE!) I didn’t see any kind of reference to a “Price Per Foot” of the building either. You want to make sure you aren’t paying a crazy price per foot that is well above replacement cost. (Example: If you can build the building for $150 / foot, but the sales price is $400-500 per foot, there are issues!!! This is usually directly correlated to rental rates). The reason we choose to invest in NNN properties with strong credit guarantors is ease of management, surety of payment and locked in lease terms. Our investors rely on their monthly checks, and returns on investments. Over time, their cash is protected and usually fully returned by year 10. In this case, it is a business decision, but I am more inclined to nudge an investor to the credit tenant Verizon store (usually credit backed by Verizon Wireless, but ot always) over a franchisee KFC store. That’s a credit risk decision that only the investor can make. 20 years is a long time. (you can sub Starbucks for Verizon too) Lastly, I have not seen any mention of Location. (Location, Location, Location). I would trust that the location is good, but it has to be a HUGE consideration when buying, especially a retail building. If you’re an outparcel to a K-Mart, Sears, Macy’s mall, JC Penny Mall… that’s an issue, and with a 20 year lease… who knows. 10 Years ago, that was a selling point, now it is not!
    Chris
    Replied over 2 years ago
    Good post. You highlighted an often overlooked issue with retail, and sometimes office properties – often the cost of specialized tenant improvements needed for a specific business are amortized in to the lease rate and ultimately reflected in the price per square foot the property is marketed at, resulting in a large spread between the value of the income producing asset and the intrinsic value of the real estate. Lenders are aware of this element of exposure and will be reluctant to lend if the spread is too large regardless of the tenant. This is evaluated on rental rate typically not price/sf but these assets are priced on income so there is a direct correlation. Reply Report comment
    Chris
    Replied over 2 years ago
    Good post. You highlighted an often overlooked issue with retail, and sometimes office properties – often the cost of specialized tenant improvements needed for a specific business are amortized in to the lease rate and ultimately reflected in the price per square foot the property is marketed at, resulting in a large spread between the value of the income producing asset and the intrinsic value of the real estate. Lenders are aware of this element of exposure and will be reluctant to lend if the spread is too large regardless of the tenant. This is evaluated on rental rate typically not price/sf but these assets are priced on income so there is a direct correlation.
    Tim P. Real Estate Investor from Danbury, Connecticut
    Replied over 2 years ago
    1 BIG consideration in NNN investments is the rent PER SQUARE FOOT (PSF). Often developers will build a nice new KFC, CVS, etc. for the tenant… and in exchange charge double the market rent. So if your KFC is 2,000 SF, then the rent is $48 PSF NNN… If the market rent is only $20 NNN – then you could be in big trouble when KFC vacates one day, especially if they go bankrupt early in the lease. Naturally the rent is going to be above market for these deals, but you don’t want it TOO high. Another consideration is the guaranty (corporate, personal from the franchisee, length of guaranty, etc.). Another is the age of the building (new = no capital improvements in near future). Another is building size/unit sizes (small = easier to lease).
    Matt R. from Sherman Oaks, California
    Replied over 2 years ago
    Perhaps let them know they could do better (7.5%) and safer in a Reit like OHI that solely invests in NNN. That would be even more hands off than owning a single tenant NNN outparcel pad. Otherwise the actual location will likely make or break this NNN long run. A commercial broker like Joel would know more on how one considers this location part. These tend to be much more sophisticated investments vs the old timey sfr model. Otherwise KFC has a franchise track record with a 12% loan default rate and compare to Pizza Hut at 6% or Jamba Juice at zero defaults. Only the exact location could save the day if this one KFC goes south at any point. Good luck!
    Matt R. from Sherman Oaks, California
    Replied over 2 years ago
    Perhaps let them know they could do better (7.5%) and safer in a Reit like OHI that solely invests in NNN. That would be even more hands off than owning a single tenant NNN outparcel pad. Otherwise the actual location will likely make or break this NNN long run. A commercial broker like Joel would know more on how one considers this location part. These tend to be much more sophisticated investments vs the old timey sfr model. Otherwise KFC has a franchise track record with a 12% loan default rate and compare to Pizza Hut at 6% or Jamba Juice at zero defaults. Only the exact location could save the day if this one KFC goes south at any point. Good luck!
    Ian Wright from Houston, TX
    Replied 4 months ago
    Hi Matt, Where can you find the loan default rates for franchisees? I’m guessing that for public companies you can pull it from their financials, but what about privately held companies?
    Scott S. from Tacoma, Washington
    Replied about 1 year ago
    Realty Income (O) REIT has mostly NNN leases. It is one of the most reliable REITs out there with a solid track record. Monthly 4.5% dividend with a 25 yr Compound Average Annual Total Return of 15.8% https://www.realtyincome.com/Home/default.aspx
    Abraham Bar Investor from Palo Alto, California
    Replied 4 months ago
    Actually owning stock in a REIT is very different from owning real estate: 1. Market risk 2. You cannot deduct depreciation, you pay income tax on those dividends 3. No like kind exchange Regarding Realty Income specifically, the dividend yield is actually 3.91%, 4.5% is the average annual growth of that yield, If you want to to be totally hands off by owning a dividend yielding stock there are better, safe options, https://finviz.com/quote.ashx?t=O&ty=c&ta=0&p=m
    Vipul Patel from Sherman Oaks, California
    Replied 4 months ago
    You can claim depreciation only if qualify as a real-estate investor. Passive investors cannot qualify to claim depreciation.
    Paul Merriwether Investor from Oakland, California
    Replied 4 months ago
    Loved the article since I was clueless on NNN commercial in general. What struck me though was that home in Venice for $2 million. I got to wondering with a down payment of $500,000 could that work??? Here are the numbers. Sale price: $2,000,000 (Clean home that has been upgraded move in ready. ) Down Payment of $500,000. Finance: $1,500,000 Loan rate: 4.2% for 30 yr’s. Monthly payment: $7,335.26 Estimated rent / Zillow $6500 / mth for Venice Beach area. Neg cash flow $835.25 not including Taxes & Ins. Taxes at 1.5% = $30,000/yr = $2500/mth. Ins at .4%/yr = $8330 = $700/mth Total Neg: $4,000/mth or $50,000/yr. or $1,500,000 over 30 yrs. WOW!!! As crazy as that sounds could it work??? Rents would go up over 30 yr’s as well as appreciation and equity as note is paid down. So what would the home value be in 30 yr’s??? Using a future value calculator with a start rate of $2,000,000 at a yearly appreciation rate of only 6%. In 30 yr’s the value would be approx $11,487,000!!!! At 7% appreciation/yr Future Value: $15,224,510.09 HELLO!!! Future rent at 2% increase/yr starting at $6500 would be $11,773.85/mth IN 30 YR’S. On a side note that $500,000 down payment earning 6% in a passive investment over 30 yr’s with periodic investments of $50,000 would grow to a Future Value: $6,824,654.90 If I could afford it, I would buy that CA home!!! Plus you can pull money out over the years!!!
    Paul Merriwether Investor from Oakland, California
    Replied 4 months ago
    Wait a minute … at 7% appreciation the home value has grown to $3,000,000. You can do a 70% refi on a rental and pull out approx $1,000,000!!!!! Pulling out that money will NOT affect the value of the home. It’ll still grow in value at 7% the next year on that $3,000,000 value or approx $210,000!!!!
    Paul Merriwether Investor from Oakland, California
    Replied 4 months ago
    I left out that growth to $3 million was after ONLY 6 yr’s!!! In the next 4 yr’s that value grows to approx $4,000,000. Do another refi at 50% of value pulling out $2,000,000. You now have a new 30 yr loan with a balance of approx $2,000,000. Yet you’ve pulled out $3,000,000 in the last 10 yr’s!!! As rents have increased lowering your monthly neg.
    David Feazell Real Estate Investor from Fallston, Maryland
    Replied 4 months ago
    Hey guys. I frequently work with clients looking to buy nnn commercial properties, often involved in a 1031 exchange. Keep in mind that the location, demographics, traffic counts, tenant’s history at the site, and tenant’ rent to sales ratio are all extremely important to review when considering this type of property. Additional consideration goes into the strength of tenant as well as whether tenant is a franchisee or the corporate entity. Many factors need to be weighed in on this type of acquisition beyond the cap rate and purchase price in order for the client to be protected long term.
    Paul Merriwether Investor from Oakland, California
    Replied 4 months ago
    Ben Leybovich wrote this great article on BiggerPockets >> Cash Flow vs. Appreciation: What Experienced Investors Know About the Debate That You Don’t<< https://www.biggerpockets.com/users/JustAskBenWhy