NNN cap rates in Houston area?

10 Replies

Curious if anybody knows typical cap rate ranges for NNN leases in the Houston area, for say a corporate tenant like a Walgreens or CVS. A friend of mine is curious on a deal he saw. Thanks.

Hi Robert,

I can write a book on NNN investing. I might some day when I get around to it.

I will take specifically you mentioning pharmacies and talk about nothing else. Walgreens and CVS I will expand on but leave out Rite Aid as it is not investment grade BBB- or better like the other 2.

The cap rate with the pharmacy doesn't matter as much as you think. With pharmacies it's all about the debt structure and lease term.

You have NNN absolute do nothing leases and the landlord gets a check. Then you have NN leases where the landlord is usually responsible for roof, structure, parking lot ( whatever is in the lease). Then you have a ground lease where you the landlord lease the land but do not own the building. The building reverts back to you by default generally if the tenant does not renew the option period after primary term ends.

You can also have just a payment stream as a go between for the tenant and the landlord like a bond. These have more risk and hard to get funding for.

Then you have what we call ZCF or ( zero cash flow ) deals. This is where the lease payment equals the mortgage payments for zero cash flow. The better ones have the zero cash flow end with the primary term of the lease and zero's out. Some have loans expiring before primary term ends and you can be in a negative cash flow situation with having to get new debt at a higher rate so many sell before then. The ZCF is a tax strategy play. I won't go too deep with it here. There is a pay down re-advance feature in some cases allowing you to pull out money tax free and re-invest. Example a 5 million ZCF with re-advance feature in the lease has a seller selling with 1 million equity payment to assume the lease. A developer puts 3 million in and then takes 2 million back out to reinvest proceeds.

If your friend is looking at what I think at an 8.58 cap or something that is a Zero Cash Flow property.

Buyers get excited about all of these ( cap rates) things without knowing how these properties work.

You can also have a high cap say a 8 cap but then find out there is a loan that has to be assumed at 7% rate leaving no cash flow because if not there is a huge penalty to pay it off early. The penalties can be staggering sometimes 1/2 a million or higher.

Even if no loan to assume you can have an 8 cap but then there is only say 10 years left on the lease. They will only give you a 15 to 20 year amort. as they want the loan paid down heavily before option periods kick in so that loan balance is close to dark value. This way it limits lenders risk exposure and losses. Since pharmacies CVS and Walgreens have virtually no rent increases in their 20 to 25 year primary terms making sure the debt is long term of the lease is key. If not and you have to sell you could get crushed with a loss having to move the cap high enough to entice a buyer to purchase.

Other NNN properties work completely different than this. I have not even explained everything with the pharmacies. You can get in as little as 10% down payment depending on many factors.

I hope it helps Robert. My clients let me look through things for them because I already know something won't work because of this or that. You do it everyday and you get very good at it. Brand new pharmacies and even existing are trading in the 5's to 6's range in cap. Debt is at 4's to 5 so with lender phantom reserves you might eek out 4 to 6% pre-tax cash flow and each year you are just generating pay down. There are some value add plays with pharmacies but my fingers are wearing out. Time to hit the hay.......... : )

Thanks very much for the information. That explains a lot and, yes, the cap they are stating is 8.78. You're right on the money, so to speak I will pass your information along to my friend. In determining a valuation of this property, whether the asking price is reasonable, a discounted cash flow analysis is obviously better than just looking at the asking price, NOI, and cap. I ran an analysis out to 10 years with lots of assumptions on income growth rate and discount rate of course, but the PV is about $1M less than their asking price. This doesn't include any kind of future sale proceeds, just purely cash flow, but based on the reported NOI, so if you take into account debt service and taxes, that value will likely be even lower. Does that sound right?
Thanks again Joel!
Robert

Robert a ZCF ( zero cash flow ) deal doesn't have any NOI. You would have equity build up from principal loan balance reduction. Also if the selling cap compressed over time.

For instance you buy a 4 million ZCF at 8.78 cap. The equity buy in is 500,000. Fast forward 2 years and you have 250k in principal reduction and another 500k in cap compression. You now have 500k initial money down, 500k cap compression, and 250k principal reduction for 1,250,000 if you sold and exchanged before resale costs. example the cap compresses from 8.78 to 8 cap. I am not running the exact numbers here on anything and giving a basic example.

You can have your friend come on here to post more if they like or they can contact me. The ZCF pharmacy is a tax play not a cash flow one.

True NNN the pharmacy pays the taxes, insurance, etc. plus lease payment.

Thanks again Joel for the explanation. I realize that ZCF doesn't have NOI now…didn't put 2 and 2 together at the time...I was going by what the sales ad numbers listed. They listed the NOI, cap, and asking price in the ad. It takes someone with experience and knowledge to pick out the details and realize that this is a ZCF deal. Plus, there's no land ownership, just the structure….that doesn't really make sense to me as being a good deal either.

Looking back at ad, yes it is listed as a ZCF lease hold property with pay-down re-advance option, and initial lease term out to 2032. In light of your educating me, it all makes sense! Thanks again for your input Joel.

Hi Robert,

Glad I could help. This is why instead of clients sending my 50 properties to consider I look through them myself first. I know all of these things on why something is or is not a deal due to lease term, location, assumable loan with bad terms, etc.

Remember the ZCF is not a cash flow play off of the property but a tax strategy.

@Joel Owens

As a multifamily investor looking to move to commercial, your knowledge level is so impressive and reminds me how much more complex commerical transactions are.

Thanks Steve.

I think the best investors and also brokers are constantly learning everyday to be at their best.

What you realize at any level Is that you can never know it all but you can have fun learning daily as much as you can.

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