Start to Finish... Ground Up Single Tenant NNN Lease Development

65 Replies

Originally posted by @Larry Flanagan :
"kick out" clause?

If this, then that clause...lol If this "x" happens we can terminate the lease. For instance, if this tenant leaves or the center falls to "x" occupancy, or governmental changes.... tenant can terminate with "x" notice.

It's all about the sell ability of the lease.

For instance Dollar Stores used to have rental increases in primary term and a higher cap.

So a NN with landlord being responsible for roof and structure is not appealing to buyers in years 5 of the lease on etc. You might as the developer throw in a free roof warranty as part of the sale to make the buyer feel more comfortable in the deal. Also in double net you have to watch out for things like parking lot, utility lines, etc. in the lease the landlord is responsible for. Expenses can bring that purchase mid 6 cap down further over time. If the location is strong as you say then the building could be repurposed faster if it goes dark later.

As the years go down in primary term lenders do not count the option periods so the property is harder to sell unless it's a 1031 buyer with a sizeable down payment who wants to maintain a low ltv loan status or an all cash buyer. What's available out there depends on the debt market. When interest rates rise you have to buy the land cheaper so that selling cap is higher and buyers with finance can still cash flow going in.

When I review leases for clients, I look for the kickout clauses and any other right to terminate -- my clients want to make sure the rental stream is maintained. Also, there are some clauses that put monetary obligations on Landlord - costs to upgrade to meet new ADA, responsible for haz mat, etc. and some clients worry about clauses that require Landlord to use insurance money to rebuild the property after a casualty (banks like the ability to use that money to pay off loan, so it may make it a little harder to get funding).

@Joel Owens Thanks for the insight. The average rent in the area for comparable properties is from $8.75 - $9.85 per ft2 the tenant wanted $9.50 with a .50 bump at the fifth year, but I held firm at $10.00 with no bump. Our exit plan is two fold. Ideally we will have a mail box money buyer in place to take us out prior to first months rent. Or, it will roll into one of my partners personal portfolio of net lease properties, and I will cash out. Our operating agreement is drafted with these provisions.

@Andy B. Since I am still in the LOI-prelease phase I will make sure I pay close attention to the language of the lease. I have already started the push back on the NNN responsibilities.

Thanks!!

Originally posted by @Jay H. :
@Joel Owens Thanks for the insight. The average rent in the area for comparable properties is from $8.75 - $9.85 per ft2 the tenant wanted $9.50 with a .50 bump at the fifth year, but I held firm at $10.00 with no bump. Our exit plan is two fold. Ideally we will have a mail box money buyer in place to take us out prior to first months rent. Or, it will roll into one of my partners personal portfolio of net lease properties, and I will cash out. Our operating agreement is drafted with these provisions.

@Andy B. Since I am still in the LOI-prelease phase I will make sure I pay close attention to the language of the lease. I have already started the push back on the NNN responsibilities.

Thanks!!

Wow, great thread! I would caution you about the NN lease. If its not too late, try to go with a NNN for ease of selling. Yes, you'll get lookers for the NN property, but most investors looking at single standing NNN properties are going to be critical about it. Although the location sounds superb, the lease should be just as good with no Landlord responsibilities.


Thanks!!

Wow, great thread! I would caution you about the NN lease. If its not too late, try to go with a NNN for ease of selling. Yes, you'll get lookers for the NN property, but most investors looking at single standing NNN properties are going to be critical about it. Although the location sounds superb, the lease should be just as good with no Landlord responsibilities.

@Tony Nguyen Its so funny/frustrating the whole NN vs. NNN discussions, I found myself in discussions yesterday with the tenant rep and another "professional" and both of them kept referring to NNN as NN vs.NN as NNN.....NNNNNNNNN, F%4^&^% i said to them both "from this point forward i am only referring to the lease as ABSOLUTE or NOT ABSOLUTE, I have neither the time, desire or patience to keep going in circles about the definition of NET NET NET"

I am being advised that most if not all credit tenant "variety store like" locations are not absolute net; unlike most CVS or Walgreens which are. Later that day after meeting with my contractor and finding out that the roof will have a 25 year warranty, and considering the building is four sided block, I feel these two items alone counter balance the loss of the third N. Basically- if the lease is 10 years with two- five year options Then the warranty theoretically out lives the lease....Correct?

That is not true about all being NN.

YES in recent years DOLLAR stores have all gone in most cases to NN for a new lease.

They are generally 6.5 cap to 7 cap and rent is flat for 10 years with rent increases in the option periods. Personally I think they have become horrible investments as the lease terms are awful.

You can find an Applebees with a starting cap of 7.5% for around 2 mill to 2.5 mill with annual bumps in primary term of 1.75 to 2.25 a year. The parcel size is larger also. People love these dollar stores. I think there was a play 2 to 3 years ago when they were 8 to 9 caps or better. All triple net have rent increases in primary term except pharmacy ( I have seen pharmacy have rent increase but then cap rate starts at 5 instead of 5.5 to 5.75 ask so blended cap rate is the same over the primary term ). The only benefit I see to them is they are cheap in price.

I like auto stores better for the same price with rental increases per year in primary. Since the lease cap rate is flat for 10 years make sure you get a good cap to sell at versus your cap and spread with all your costs in. The roof warranty should be fine as long as the lease doesn't have other things written in (parking lot, utility lines, etc.) that landlord pays for.

@Joel Owens Thanks for the info! Question: when you are looking at the quality of the investment, and say the Dollar type stores are horrible investments and the Applebee's (DineEquity) are good investments are you layering in the corporate risk? From my understanding the dollar type stores are corporately owned buy quality companies with "clean" balance sheets (with the slight exception of Family) , While Applebee's, owned by DineEquity is franchisees driven and not corporately guaranteed. This would make me feel the risk associated with Applebee's vs. Dollar Tree is greater for the Applebee's real estate?

Oh, I like the Auto Stores as well. I just tied up a parcel that meets my market factors and am hoping to secure one of the three players (Zone Reilly Advanced) I may do a similar write up on it as well.

Hi Jay,

Not true about the Applebees with no corporate guarantee. While franchising is part of their concept along with other restaurant brands it doesn't mean they have only franchised locations.

4 levels of security:

Corporate guarantee: BEST

Subsidiary : For example corp Applebees but only 100 stores over 2 states and not all of them. BETTER

Large franchisee: GOOD

Small to new franchisee with one or more locations: FAIR

In general the more the risk the greater the annual rental increases and starting cap rate.

You look at location and sales versus the Applebees national average ( around 2 million annually) to determine how that store is performing. If the seller doesn't want to share sales figures that is a big red flag.

How has your deal been progressing??

Today I am finalizing my redlines in the lease with our counsel. Yesterday I sent the draft of the lease off to two of the Life Lenders that I deal with so they could give me a "pre opinion" regarding items that may be of issue with their underwriting/insurance departments.

Discussion item for the Developers and Contractors on the forum. What do you prefer and why?

Cost Plus or Flat Fee?

If its Cost Plus 10% do your typically see the addition of a flat fee weekly, for administrative items of the contractor i.e. cell phone, vehicle, fuel?

@Karen Margrave

@Jay H.

As a commercial hotel contractor I would never agree on a cost plus 10% agreement. With that being said we currently only do redevelopment work and new construction is definitely different. However I would never trust that the contractor is actually doing a cost plus 10% deal...there are so many ways to hide profits and inflate costs in construction. I just don't see it being very clean on a smaller deal. Maybe a 100MM development project that has Ernst & Young auditing the contractor however on a smaller deal it's just not as cut and dry. And why worry about how much the contractor is making? You want the contractor to make money. I would go with a fixed fee all the way. Make sure you get multiple solid bids from experienced contractors and go with the one with the most value (not necessarily the lowest cost). Check out recent similar projects that they have completed and talk with the client about the process and their experience.

Thanks for the insight @Chris Winterhalter . I am still reviewing my options for contractors compensation structure.

Chapter 4 "getting the parcels closed"

Wow, what a crazy month! So, today I close on all of the parcels. Let me tell you it has been a hectic month. I have finalized my lease with the Tenant, and continued with my due diligence on all three parcels. Remember one parcel was a vacant lot, one was a used car dealership and the third was a closed BP station. My focus with regard to environmental issues was naturally the closed gas station even though I had a clean tank letter from DEP dating back to when the tanks were removed...mistake! Well, when my phase one came in an all three parcels the vacant lot showed that back in the 50's there was salvage yard operating on the site and there nowhere could anyone find where a phase two had been preformed, so lucky me i get to be the proud new owner of a phase two invoice. Luckily, I thought ahead and got pricing for both phase two field work and geo-tech field work separate, then called back and was able to lower the cost of the Geo work by requesting the drilling rig do all the boring (environmental and geo) on the same trip, thus lowering my bill substantially. But what was even better than that, the Geo work came back and noted substantial nonuniform fill on the site made up of rubble, glass and metal anywhere from 1'-2' deep. This gave me the ammunition to go back to the seller of that parcel and negotiate the price down substantially. Normally one would have the Geo work done after closing and be stuck with results. 

Well, the environmental phase two came in clean for all three sites as did the title. 

As for the out-parcel tenant I am still in negotiations with several credit tenants in the fast food and cellular industries. Two of the fast food chains want to purchase a pad ready site, but i am a bit reluctant because I feel I am leaving too much on the table vs. the value of a long term lease. 

Next......permitting and plans go out for bid.

Sorry for the gap in updates, but I have been swamped with the project. I found myself relaxing this weekend and catching up on the Pod Casts, and realized I was neglecting this thread.

Chapter 5 - Permitting- County Commission Approval- General Contractor Issues/Cures Dealing with Bids.

Originally posted by @Joel Owens :

That is not true about all being NN.

YES in recent years DOLLAR stores have all gone in most cases to NN for a new lease.

They are generally 6.5 cap to 7 cap and rent is flat for 10 years with rent increases in the option periods. Personally I think they have become horrible investments as the lease terms are awful.

You can find an Applebees with a starting cap of 7.5% for around 2 mill to 2.5 mill with annual bumps in primary term of 1.75 to 2.25 a year. The parcel size is larger also. People love these dollar stores. I think there was a play 2 to 3 years ago when they were 8 to 9 caps or better. All triple net have rent increases in primary term except pharmacy ( I have seen pharmacy have rent increase but then cap rate starts at 5 instead of 5.5 to 5.75 ask so blended cap rate is the same over the primary term ). The only benefit I see to them is they are cheap in price.

I like auto stores better for the same price with rental increases per year in primary. Since the lease cap rate is flat for 10 years make sure you get a good cap to sell at versus your cap and spread with all your costs in. The roof warranty should be fine as long as the lease doesn't have other things written in (parking lot, utility lines, etc.) that landlord pays for.

Not to hijack this post but- Any thoughts on Advance Auto or Carquest?

I have heard a certain Dollar Store is brutal in negotiations and  most of it's buildings are 3 sided metal making it a lesser value in releasing.  Just what I heard.

Any updates for us, Jay?

http://en.wikipedia.org/wiki/CARQUEST

Advance owns CARQUEST.

As I said before dollar stores tend to be in sub-standard locations and have a brick façade with 3 sides metal. Years ago when they were at an 8 cap and had increases in rent in the primary term they were a cheap investment with a high pop for return.

Now they are in love with themselves.

I would rather personally own a retail strip center NNN built better in a better location with break even occupancy on multiple tenants. There will usually always be buyers for the dollar stores as they are a low entry point.

The auto stores I can still find 2% annual rent increases in the primary term and a good starting cap rate close to 7. So the blended cap rate over time with increases is pretty good.

The auto stores generally have the same space requirements of the pharmacies. With dollar stores you have to watch out for ones right on the corner that have gone into a building where a pharmacy use to be. Upon reviewing the lease the seller is claiming a high cap with say 5 years left on the primary term.  Examination discovers the CVS pharmacy moved to a better location years ago. They were still obligated to the remaining primary term on the lease so they sub-leased the space to the Dollar Store until the primary term runs out. The Dollar Store can't pay the same per sq ft rate the CVS does for example. So CVS subsidizes the rent and collects the difference from the dollar store. The dollar store is happy as they get a corner location they couldn't otherwise afford for rent rate. So you will see these types with high caps but understand once primary term ends the dollar store will re-trade what they pay when the pharmacy stops making up the difference. So you basically have an income stream for XX years and then it drops way down. I would buy one of these on what the income will be when the subsidy goes away. Seller will not like it of course but I do not have to buy if they do no accept my proposition nor do my clients.

It's important if you want to develop properties that you have someone with experience look at it FIRST to know what the end buyer will want. I was contacted the other day and someone built a bank. They believed they had NNN but upon reviewing the lease it was discovered they had a NN and not only that banks usually give 2% rent increases in the primary term. This one had flat rent in primary term and in the 2 options had no rent increases!!

So basically this developer left a ton of money on the table because now they are going to have to sell at a higher cap to offset the sweetheart lease to the tenant. There were a bunch of other things I found but the sad part is they put 100% trust on their attorney back then with the lease and didn't get other opinions from what I can see.

They can still sell hopefully and learn from this for their next project to negotiate the lease with the tenant with the end buyer in mind when they eventually want to sell.      

Originally posted by @Joel Owens :

http://en.wikipedia.org/wiki/CARQUEST

Advance owns CARQUEST.

As I said before dollar stores tend to be in sub-standard locations and have a brick façade with 3 sides metal. Years ago when they were at an 8 cap and had increases in rent in the primary term they were a cheap investment with a high pop for return.

Now they are in love with themselves.

I would rather personally own a retail strip center NNN built better in a better location with break even occupancy on multiple tenants. There will usually always be buyers for the dollar stores as they are a low entry point.

The auto stores I can still find 2% annual rent increases in the primary term and a good starting cap rate close to 7. So the blended cap rate over time with increases is pretty good.

The auto stores generally have the same space requirements of the pharmacies. With dollar stores you have to watch out for ones right on the corner that have gone into a building where a pharmacy use to be. Upon reviewing the lease the seller is claiming a high cap with say 5 years left on the primary term.  Examination discovers the CVS pharmacy moved to a better location years ago. They were still obligated to the remaining primary term on the lease so they sub-leased the space to the Dollar Store until the primary term runs out. The Dollar Store can't pay the same per sq ft rate the CVS does for example. So CVS subsidizes the rent and collects the difference from the dollar store. The dollar store is happy as they get a corner location they couldn't otherwise afford for rent rate. So you will see these types with high caps but understand once primary term ends the dollar store will re-trade what they pay when the pharmacy stops making up the difference. So you basically have an income stream for XX years and then it drops way down. I would buy one of these on what the income will be when the subsidy goes away. Seller will not like it of course but I do not have to buy if they do no accept my proposition nor do my clients.

It's important if you want to develop properties that you have someone with experience look at it FIRST to know what the end buyer will want. I was contacted the other day and someone built a bank. They believed they had NNN but upon reviewing the lease it was discovered they had a NN and not only that banks usually give 2% rent increases in the primary term. This one had flat rent in primary term and in the 2 options had no rent increases!!

So basically this developer left a ton of money on the table because now they are going to have to sell at a higher cap to offset the sweetheart lease to the tenant. There were a bunch of other things I found but the sad part is they put 100% trust on their attorney back then with the lease and didn't get other opinions from what I can see.

They can still sell hopefully and learn from this for their next project to negotiate the lease with the tenant with the end buyer in mind when they eventually want to sell.      

 Yes I know advance owns Carquest, that is why I asked :).  

What would you consider the general percentage of expenses for a new NN versus a NNN when you assess properties;)

A brand new building if it's NN you try and get the seller to offers warranties and credit back to the buyer. You can request the seller purchase a warranty on an older building that has fallen out of coverage.

Also the seller could be made to put a new roof on but if the seller is doing it likely on the cheap. So it goes back to the buyer wanting control of the repairs to make sure they are completed properly.

NN you can usually get a 75 basis point premium on buying over NNN. If the tenant is national or a franchisee with a credit also makes a cap basis differential as well as the location.

Each property is a case by case analysis although there are general commonalities. Auto Zone is one of the strongest auto stores.   

I am well on my way with the development.... I am sorry for the gap in updates, but WOW this process is not for the weak at heart. I have very detailed notes on the entire process up to this point. What I have to figure out is, how to tastefully detail out my experiences without offending any of the participants that make up the lessons learned. Not that they are readers of this, or maybe they are??

@Jay H.

First most, thanks for posting this.  I'm interested in a similar development in CA and have searched the internet for this type of information, your journal as well as the conversation between everyone has got to be the most enlightening and straight-forward education I have found so far.  Also, hat's off to you for creating value out of thin-air!

Had a few questions that maybe others on the forum would benefit from being asked too; thanks again:

- Regarding initial contact with the tenant reps, how did it go? And how did you obtain contact info for each tenant rep?  Many are simply posted on the website but did you ever consider using tenant brokers?


-  Can you clarify your development terminology, horizontal vs. vertical?  Is horizontal referring to site work, demo, grading, etc and vertical referring to actual buildings cost of the structure?  Does the $65 psf include soft costs (entitlements, architecturual and site costs)? 

- How did you obtain traffic counts? did it yourself or hire someone?

- How long did it take tenants to do their feasibility analysis? (you mentioned about 1 month?)

- Regarding your construction loan, how much do you need down?  20% equity?

- During the LOI did you have any room to negotiate or was it pretty much "their way or the highway?"

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