1031 exChange now for a NNN property. What should I be looking 4?

Question

Hello, I am in the middle of a sale and anticipating a 1031 exchange for a NNN. I’m looking at my options. I’m looking primarily in the northeast (MA). I’m seeing 4.5 to 6% caps for 1.5 to 2.3 million dollar properties. Interested in getting one of these but seeing only 5 years left on leases with options but hard to anticipate tenant will resign. Looking at banks, fast food. Not so sure about dollar general but they seem to have longer leases. looking to put down more equity and new mortage for a longer lease NNN but lower cap (10-15 years) to have stable income. Franchise vs Corporate? How’s to plan for stagflation looking economy. I plan to also diversify my portfolio with residential condos outside the greater boston area. Thank You!

Joel Owens · Answer

I can't give absolutes on loans. Generally there are still 70% LTV loans for properties with investment grade credit tenants and 10 years or more remaining on primary term lease with population of at least 50k in a 5 mile radius and average income of 50k to 60k plus. The loans typically are mid 3% type range with 30 year amortization fixed for 10 years.

These loans the NNN lenders want U.S. citizens. Sometimes they will do green cards etc. but want more down than the 30%. Additionally say someone is retired with little ongoing income except for properties but great net worth. In those cases with my clients I have seen lenders require 35% down even with investment grade credit tenant.

They still qualify borrowers with investment grade tenants it's just maybe 80% on tenant and 20% on borrower. That is because tenant credit is so strong the chance of going dark in primary lease term is very small. When you start moving down lease guarantee strength and size of company the risk profile changes from the lender. They put maybe 50% on tenant and 50% on borrower for medium size companies and 80% on borrower and 20% on tenant for the smaller companies or one off mom and pop types. With tenant strength being less odds are tenant goes dark in primary lease term and they want borrower to have high ongoing income to (float the note) while property gets repositioned for lease up (strong warm belt state markets can be under 6 months for 10k sq ft and below type properties and up to 1 year. Cold belt states and small markets could be years just depends on the new lease up rate and would that work for smaller tenants and their business model. This is exactly why I like stronger markets. If it's okay tenant with higher rents close to market in a small area you are just asking for a bad outcome when they go dark.

If you are Canadian then there are some banks here from Canada with location in U.S. that might give foreigner loans. Might be more than 30% down whereas other NNN lenders would just pass. The other part is the DSCR ( debt service coverage ratio ). You could have strong location, tenant, lease term but cap rate it is selling at and interest rate available dictate 35% down to 40% down needed to meet lender coverage requirements.

That 3 million and below price point is so tough because a huge buyer pool looking to sell of multifamily or other assets and go passive. If someone's net worth is say 1 million and then jumps to 5 million a lot of them take the foot off the gas and just coast with investments to outpace inflation. They would rather have that time to do as they wish then obligations in exchange for active yield versus passive yield. I am talking about regular individual investors and not the syndicators and fund typed burning the midnight oil constantly hunting for the next deal.

In that range you are mentioning expect to get about a 5% cash on cash year 1 off the down payment and with mortgage paydown about 9 to 10% overall return. We are in hyperinflationary times. Right now it is because of logistics and corona affect. In a few years that likely settles down and prices drop from the peaking now for costs of good but not back down to what it was pre-corona as regular economic cycle inflation sets in for a longer term. So if people want to place money trying to match hyper inflation year for year right now then stabilized single tenant NNN is not the investment for them. If they want 5 to 6% rent growth for a blip in time they will need more multifamily, residential rentals, storage, hotels etc. If they want that yield they will have to work for it unless they invest into a syndicate type deal.

1031 investors like the poster would have to looking more into DST's if they qualify to invest and yield again not going to be super high. There are some owners of dark buildings for retail trying to position new lease with tenant for a minimum rent amount or CPI rate whichever is higher to benefit from inflation. When inflation is low you do not want CPI as that tends to be less than getting 2% annual rental increases. Tenants are smart cookies and know inflation like this is for a few years most likely and not the full primary lease term so will not want to sign that whole time to pay high rates. So it's a dance and a negotiation getting something landlord is happy about and tenant while not happy will accept and still sign the lease. There is part art and strategic science to it. I would rather let a property sit vacant for months and months to get the right lease for me that gives me the lease value and cash flow while I own it and when I exit.

I have seen some doctors with a local bank get 75% to 80% LTV for STNL but they are super strong like tens of millions net worth and make millions per year and personally guarantee everything and have to keep all accounts at that bank for business. Even then rate might be slightly higher for loan and amortization 20 to 25 instead of 30 year.

To get high return in NNN usually people invest with me on my turn arounds. Another option is they become a developer themselves but that takes a ton of work and again working for active yield versus passive.

No legal advice of course. Hope it helps.

Joel Owens · Answer

If it's under 5 years left on lease then generally not financeable with good terms if debt available at all. There is just not enough burn off time with a loan for lender to get with comfortable dark value with mortgage paydown if tenant does not renew. That is why amortization can go down to 10 years etc. and no cash flow. Basically buyer is parking money like in the bank but hoping with rental increases and land values will go up in time.

Some people will buy a 5 cap if location is an (A) and hardly comes to market. Maybe property could also be on ground lease where rent is 20 a foot and NNN market absolute lease ( land and building ) is 40 a foot rent.

Could also be old junk building with good tenant in urban core where could eventually tear down and go higher with street retail and apartments above it.

There is short term equity value, long term, and the cash flow.

Many of my clients are very wealthy so do not need super high returns. It's all relative to age in life, active versus passive yield, etc.

These days I value time more than money. More money can be created but you do not get that time back.

Joel Owens · Answer

There are some lenders that consider financing to non-citizens. It's a case by case basis. I would have to introduce you to them to see what is possible.

Other capital markets lenders I use won't do loans for non-citizens as the lenders pass.

Non-citizen investment grade tenant long term lease looking more 35% down instead of 30% best case and some will want 40% down. Lenders have lots of U.S. buyers applying for loans so will only take on the extra work of non-citizens on their terms.

Joel Owens · Answer

2.5 to 3 million price lot of more opportunities for quality open up for location nationally and strength of the tenant.

If it's 1.5 million price point would just likely stick to residential. This is why I ask clients if they will add to the 1031 exchange for down payment when small 1031 proceeds.

A high quality residential might be 500k to 1 million in a strong market but for commercial 1.5 million might get you small suburban to rural area with a lot of location risk. Dollar General flat rent for 10 years usually in primary lease term so not blending up of the cap rate over time.

Lenders normally look for 10% post liquid after down payment and net worth close to the loan amount.

Example 3 million

Credit tenant likely 30% down or 900,000

2.1 million loan

Post liquid after down payment 210,000

Net Worth 2,100,000

Closing costs: about 60k

John M. · Answer

I would stay away from stand-alone traditional banks as they are downsizing due to technology. Fast food is okay as long as you have the traffic counts to support it. Sounds like you want to go conservative so I would go with a Starbucks drive through as they are all corporate stores. Dollar stores will have a higher cap rate but may not be in the best locations if they go dark. Hope this helps

Joel Owens · Answer

Brandon Hicks most NNN STNL lenders do not touch loans under 1 million dollars. Investment grade credit tenants in smaller price ranges (3 million) and under go for 4 to 5 cp rates. With interest rates fixed for 7 to 10 years and 30 year amortization. When you have single tenant lease with fixed rent increases you want long term debt. So if you are paying 4 to 5% interest rate and cap rate is that the DSCR and everything else doesn't work especially at high leverage like 75% to 80% LTV.

Those arm's like you mention or more for active type real estate dark spaces, partially stabilized value-add, etc. so if interest rate jumps you fully stabilized cap rate to cost still cash flows even with higher future rates.

Hai Loc · Answer

@Joel Owens

What if my net worth surpasses debt service?

Or equity value of my US properties exceed my loan

Justin Lau · Answer

Joel you have some great points here. There is a lot of strategy and art to this. I was considering NNN but would need to diversify and take on a lot more debt to than I am comfortable with. I will have to be more active than passive because I will rely on the income of these investments. And I may have to look outside of my area in New England as cost of building is so high. So maybe be active in something I can control more than a STNL. If a NNN goes dark and I don’t have my exit strategy in place or how to take on that loss, I’ll be in a bad position. Looks like have to work it for some time to increase my wealth either investing in value add residential here in the Metro Boston Area since I have some experience in that. But prices are insane and have to play the long game. Maybe sit on my cash for a bit, get a job to cover expenses till the market cools down and I make a purchase. I guess my question is why would people want 3 million and under 5 caps with 5 years left on the lease? Are they just in a position where they need to park money and have no other choice but to get out of their current investment holding?

Hai Loc · Answer

Can you still get 70% LTV on a NNN STNL between 2-2.5m?

Brandon Hicks · Answer

@Joel Owens with the terms you outlined up above and the loan not being crazy big, why not look at smaller banks local to the property? We do much smaller commercial deals and in several states but we've had good luck with local banks. It's typically 20 year term (5/1 ARM) and 20-25% down but the closing costs are minimal and rates have been in the 3.95-5% range on the deals we've closed in the last 6 months. Better rates for deals we've done in our home area.

1031 exChange now for a NNN property. What should I be looking 4?

1031 exChange now for a NNN property. What should I be looking 4?

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