1031 Exchanges

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Will F.
  • Investor
  • Los Angeles County, CA
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1031 NNN strategies??

Will F.
  • Investor
  • Los Angeles County, CA
Posted Jan 28 2022, 09:47

To anyone who did a 1031 into a NNN deal (A class tenants long term lease etc), what were the pros and cons for doing these deals?

What was your individual strategy and reason for uplegging into a NNN deal?

What's your end goal, or exit strategy for these?

Are they difficult to sell later or more costly in any way to resell?

I understand management requires less hands on work, but what about the long term tenants when they do leave or a problem comes up?

Any major risks?  I'm assuming if the population of some of these small mid west towns decrease, or theres a major recession certain brands could have issues.  I also heard that some of these leases are guaranteed by the central 'corporation'.  But I also assume during a bad recession certain businesses go belly up as well

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Jon Taylor
  • Pasadena, CA
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Jon Taylor
  • Pasadena, CA
Replied Jan 28 2022, 14:38

@Will F. -

Great questions! I didn't buy a NNN investment property personally last year, but I work with an acquisition team that purchases $100M/mo of this asset class specifically for retail and institutional buyers.

Goals (reasons for purchasing NNN): Typically, the buyer is looking for income, not growth. The data through the last 20 years of bull and bear markets show amazing consistency of income over the hold period. Most investors are looking for "mailbox money," however, it's not 100% automatic.

Exit strategy: My buyers were looking to hold in perpetuity. The retail buyers expected a step-up in basis event (death) at some point within the next 20 years, and they expected this asset to enter their estate. Again, they were looking for stable income as a % of their total net worth in investment real estate (something like 20-50% depending on age and exposure). The exit entirely depends on your ability to work with the tenant on lease options and extensions (which depends entirely on the quality of YOUR asset within THEIR national portfolio.)

Difficult to sell: Not today! Demand is crazy high for this asset class across all investor classes. NNN assets trade on the lease and the demographics of the location. Valuation is entirely different than residential investment RE. Factors include: length of the lease, quality of the tenant, traffic, population count, crime stats, retail sales ratios etc...

Management considerations: The three most imporant events in a NNN lease that are absolutely critical are 1) The acquisition, 2) The lease negotiations; and 3) The exit. A comprehinsive understand of the way that each tenant trades is critically important. There are brokers who focus on each tenant, I'd makes sure you are dealing with an expert in Walgreens, Dollar General, CVS, Kroger, etc...   

Risks: Tenant quality and location are major risks. For instance, 10 years ago you could have chosen to buy a Walgreens or a RiteAid. Your investment outcomes would have been very different had you chosen one over the other - and that's in a VERY similar asset class! The value of the property (hypothetically) is depreciating over the lease term (as the length of the lease expires). You trade upside for income stability, and your ability to preserve equity entirely depends on the acquisition techincals and the performance of the specific location and the national tenant over time. 

2021 saw record high demand in that asset class, and we're seeing continued focus on that asset class into 2022. 

Happy to talk more specifics if you focus on a tenant, and I'm sure others will have plenty of input.

- Jon



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Dave Foster#1 1031 Exchanges Contributor
  • Qualified Intermediary for 1031 Exchanges
  • St. Petersburg, FL
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Dave Foster#1 1031 Exchanges Contributor
  • Qualified Intermediary for 1031 Exchanges
  • St. Petersburg, FL
Replied Feb 16 2022, 16:36

@Will F., investors love them for the long term aspect and control without management. It's a wholely owned asset. but the taxes maintenance and insurance are the responsibility of the tenant. And leases tend to be much longer than residential or regular commercial space leases. NNN properties are designed to be held long long term. So time and lease escalation increase the market value of the property.

Yes, a building going dark can be a bummer.  But in a situation with a corporate guarantee the payments generally continue the full term.  Due diligence of the structure, lease, and tenant is. paramount.

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John Mckee
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  • Fairfax, VA
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John Mckee
  • Investor
  • Fairfax, VA
Replied Feb 16 2022, 17:36

I own some of these class A NNN deals. The lowest risks deals are a ground lease with a well known tenant in a high traffic area. In other words you only own the dirt on a ground lease deal. The tenant owns and takes care of the building and all NNN expenses. Not all my deals are like this but I just wanted to point it out. My strategy has always been about controlling the asset and having passive income. The downside is that the cap rates are very low in today's market depending on the deal. I usually finance these deals so that I don't bury all my cash in the property. I have it cash flow just enough to please the bank. The strategy is to hold for a long time. I may trade up after 10 years if I find the right opportunity but also happy to hold. My first deal was a 1031 where I sold a residential rental property and used the funds for a bigger commercial deal. Why did I do it at the time?......Because over a 9 year period my rental property tripled in value for no reason (last housing boom that ended in 2008). I've never seen that kind of money in my life, not even in my 401K. I got scared and parked it in a class A asset. There is always risk. During the recession of 2009 I had to give 2 tenants a discount on rent for a short time. I did the same during Covid. One of them went out of business before Covid only because they were poorly run. In retrospect it wasn't a big deal because we had a Class A location so it was easy to lease back up. It appears we are in another boom of sorts now so if you made a lot of money through natural appreciation it may be a good time to trade up or at least leverage/refi to to keep growing your business. Hopefully this gives you some perspective and feel free to PM Me. Good Luck!