thoughts on NNN lease property

20 Replies

Hey everyone, I would love some input on a property I am considering.  This is preliminary info so all the details are not in but would love your thoughts on first glance.  National company, BBB- rating.   National retailer developing next door with strong sales.  My concerns are:

The demographics only predict a 2% increase in population for the area.

5 years left on the end of the lease.  Option to renew with a 5.9% increase.

scenario 5/25
Purchase Price: $800,000
Equity: $240,000
Debt: $560,000
Interest Rate: 4.5%
Fixed: 5 years
Amortization: 25 years
NOI: $60,000
Debt Service: $37,352
Cash Flow: $22,648
Cash on Cash Return: 9.4%
Cash on Cash Plus Prinicpal Paydown year 1: $35,053
CoC+ PP return: 14.6%
Debt at the end of 5 years: $492,004

Let me know your thoughts.  :)

3 points but there is more but just these three first.

1. Just because it is a national tenant brand name DOES NOT mean you have ultimate lease security. This could be a subsidiary of the parent corp. guaranteeing this location. Could be a large franchisee with the national name. Could be a small franchisee. So you have to read the lease to see WHO is on the hook for this building.

2. The rents on the lease are they above market (pre-recession), at market, or below market?? If above market the appraiser will likely discount the (underwrite able cash flow) for the lender. The lender will plan on if the property goes dark after the primary term or the tenant defaults early then you will be releasing to a second or third generational tenant at below market or at market per sq ft rates. The lender will also ear mark for estimated TI's (tenant improvements), and LC's ( leasing commissions).

3. The loan terms you are quoting do not happen usually with a lease with 5 years left on the primary lease term putting 25% down. The appraiser will perform a "dark value " for the lender. The lender will want to make the down payment amount and amort. schedule as such that when the primary term ends the loan balance will be close to or below the dark value. They do this so if the tenant does not renew and they have to foreclose that the chances of getting back almost all the money they lent out are high. So typically in these situations with 5 years left the lender comes up with something like 35% down and a 15 to 20 year amort. which will affect your cash on cash returns.

Much more than this but you need to dig in the lease first. It's all about the lease.

Hi Marylyn,

Numbers look fine moving forward.

First, I never give any credence at all to BBB ratings, meaningless as they are consumer oriented and, the good standing often comes from the membership fees and donations of the business, it's more of a PR concept than a regulatory type oversight of members operations.

Principles on the lease are critical as to guarantors. Commercial leases generally require financial disclosures over the term of the lease, the strength of the tenant needs to be assessed.

I tell those getting into commercial leasing that they really need to understand the business of the tenant, to some degree, the bigger they are, such as Wal-Mart the less you really need to know as to the details, but a small operation, mom and pop under a franchise needs more attention, it goes to the sophistication of management.

The major retailer moving in next door, is this a complementary business or more competitive, having an Allied Paint store and having Lowes move in next door, so that issue needs to be clarified.

What's the likelihood a tenant would move? A national grocery chain store in an establish mature area with slow growth won't likely be moving building a new location, your low growth can be a good thing, depend on the business conducted. A sporting goods store that is more sensitive to growth, increasing sales to school activities and recreational participation may be a different issue, so again, understanding the tenant's business and future growth or survival is critical.

Is the building unique to the tenants use that is difficult to be duplicated by competing properties? Again, a grocery store may be easily converted into a retail department store type thing, but a grocery store going into a building that simply has open space can be very costly due to plumbing and food storage equipment. Costs of conversions by future tenants can lead to discounted rents as a concession.

Rents paid now, for appraisal purposes will lean more to market rates for comparable space, higher rents do increase value over the expected terms remaining. The expected rents over the loan term aren't simply considered as a stable annuity income, but a series of uneven cash flows considering expected market influences, vacancy, lease up periods, inventory of similar buildings, flexibility of use, functionality and population trends and many other aspects. The more volatile and active the market may be the more that can influence pro forma estimates, if it's the only large grocery store in the area, there will be less concerns as to alternative uses and change of use.

Lenders will be relying on the current lease and the concerns mentioned in their debt coverage analysis regardless of what an appraiser may use to evaluate value, they are not related areas as one is to cash flow, the other to asset evaluation.

Just to the numbers shown, initially it looks fine, good, but there is much more due diligence required to determine if it's a good deal. You can do it I'm sure!  :)  

     

"The demographics only predict a 2% increase in population for the area."

Over what time frame?  What's the job growth trend/rate?

If the building goes dark, how likely are you to re-lease it?   Generic box or distinctive design associated with one business?  

How are this store's sales compared with the company's other stores?  Sales trend?

What's the replacement cost of the building?  I'd be nervous if I were paying much more than replacement cost. 

Good stuff from Joel and Bill above, as usual. 

Originally posted by @Joel Owens :

3 points but there is more but just these three first.

1. Just because it is a national tenant brand name DOES NOT mean you have ultimate lease security. This could be a subsidiary of the parent corp. guaranteeing this location. Could be a large franchisee with the national name. Could be a small franchisee. So you have to read the lease to see WHO is on the hook for this building.

2. The rents on the lease are they above market (pre-recession), at market, or below market?? If above market the appraiser will likely discount the (underwrite able cash flow) for the lender. The lender will plan on if the property goes dark after the primary term or the tenant defaults early then you will be releasing to a second or third generational tenant at below market or at market per sq ft rates. The lender will also ear mark for estimated TI's (tenant improvements), and LC's ( leasing commissions).

3. The loan terms you are quoting do not happen usually with a lease with 5 years left on the primary lease term putting 25% down. The appraiser will perform a "dark value " for the lender. The lender will want to make the down payment amount and amort. schedule as such that when the primary term ends the loan balance will be close to or below the dark value. They do this so if the tenant does not renew and they have to foreclose that the chances of getting back almost all the money they lent out are high. So typically in these situations with 5 years left the lender comes up with something like 35% down and a 15 to 20 year amort. which will affect your cash on cash returns.

Much more than this but you need to dig in the lease first. It's all about the lease.

 As I said I do not have all the details as this is my first look, I am trying to decide if it makes sense to continue analyzing.  I agree a national lender does not mean lease security, however it is more secure then others hence reflection in the cap rates.  It is a large auto store name, it is not a franchisee. I am told by the listing agent they have a lower rate for 7 years which I found hard to believe so I used the rates from my lenders.  In speaking with several lenders on other commercial properties I have been getting these rates- not sure as to why as you have said this is not the norm. Perhaps there is another catch I have not seen yet. 

Originally posted by @Bill Gulley :

Hi Marylyn,

Numbers look fine moving forward.

First, I never give any credence at all to BBB ratings, meaningless as they are consumer oriented and, the good standing often comes from the membership fees and donations of the business, it's more of a PR concept than a regulatory type oversight of members operations.

Principles on the lease are critical as to guarantors. Commercial leases generally require financial disclosures over the term of the lease, the strength of the tenant needs to be assessed.

I tell those getting into commercial leasing that they really need to understand the business of the tenant, to some degree, the bigger they are, such as Wal-Mart the less you really need to know as to the details, but a small operation, mom and pop under a franchise needs more attention, it goes to the sophistication of management.

The major retailer moving in next door, is this a complementary business or more competitive, having an Allied Paint store and having Lowes move in next door, so that issue needs to be clarified.

What's the likelihood a tenant would move? A national grocery chain store in an establish mature area with slow growth won't likely be moving building a new location, your low growth can be a good thing, depend on the business conducted. A sporting goods store that is more sensitive to growth, increasing sales to school activities and recreational participation may be a different issue, so again, understanding the tenant's business and future growth or survival is critical.

Is the building unique to the tenants use that is difficult to be duplicated by competing properties? Again, a grocery store may be easily converted into a retail department store type thing, but a grocery store going into a building that simply has open space can be very costly due to plumbing and food storage equipment. Costs of conversions by future tenants can lead to discounted rents as a concession.

Rents paid now, for appraisal purposes will lean more to market rates for comparable space, higher rents do increase value over the expected terms remaining. The expected rents over the loan term aren't simply considered as a stable annuity income, but a series of uneven cash flows considering expected market influences, vacancy, lease up periods, inventory of similar buildings, flexibility of use, functionality and population trends and many other aspects. The more volatile and active the market may be the more that can influence pro forma estimates, if it's the only large grocery store in the area, there will be less concerns as to alternative uses and change of use.

Lenders will be relying on the current lease and the concerns mentioned in their debt coverage analysis regardless of what an appraiser may use to evaluate value, they are not related areas as one is to cash flow, the other to asset evaluation.

Just to the numbers shown, initially it looks fine, good, but there is much more due diligence required to determine if it's a good deal. You can do it I'm sure!  :)  

     

 Excellent points as always Bill,

The tenant moving in next door is a national grocery chain.  This business I am looking at is an auto parts store.  One interesting point is the selling broker has a lower quote on financing preapproved.  I agree I need to dig much deeper and plan to, I find that my risk tolerance is low yet I expect the reward. Just trying to find a deal with the happy medium.

Originally posted by @Jon Klaus :

"The demographics only predict a 2% increase in population for the area."

Over what time frame?  What's the job growth trend/rate?

If the building goes dark, how likely are you to re-lease it?   Generic box or distinctive design associated with one business?  

How are this store's sales compared with the company's other stores?  Sales trend?

What's the replacement cost of the building?  I'd be nervous if I were paying much more than replacement cost. 

Good stuff from Joel and Bill above, as usual. 

 Excellent points and all of my questions too.  :)

I would assume that BBB- rating is a S&P bond rating.  Nothing to do with Better Business Bureau.  Which I do agree with @Bill Gulley  is useless organization.  A BBB- S&P rating is VERY poor.  Its just one notch above a speculative, non-investment rating.  Nine notches below the highest rating.  Whats the history of this company?  Is their bond rating falling or are they on the mend?

How big and how purpose built is the building?  What is the land value.  There are hundreds or thousands of empty big box stores all over this country that are worth less than the land value because someone would need to raze the existing building.  I've watched retail building here sit empty for years before a tenant moved in.  What's the situation with similar building that are empty in your area?  None? An ocassional one that gets a new tenant quickly?  Or several that have been empty for a long time?

Can you cover the payment if you don't have a tenant?  For several years?

As mentioned the BBB ( Better Business Bureau) is not what is being discussed here.

BBB- is the minimum rating CTL ( credit tenant lenders ) give the best rates on. Anything below BBB- is considered junk status where it is credit rated but not investment grade.

Now just because a company is BBB- doesn't mean they are bad. They could be on the upswing with solid fundamentals or the downswing. Some companies were downgraded from A to BBB just because they are in expansion mode and they have taken on a lot of debt but their books are extremely strong.

The main one lenders look at for lending is S & P. There is also Fitch's and Moody's.

S & P

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Marylyn the difference is you are getting told stuff on the phone by mortgage brokers and listing brokers that probably know nothing to very little about the process. Think about if you put 25% down and had a 25 year amort. you would pay down very little in a span of five years before the option renews.

Now if you are willing to do a personal guarantee with full unlimited recourse, and cross collateralize of other assets the lender might make an exception.

The difference is I look at hundreds of NNN properties a week and have been doing it for years and years. I know what's in the leases. I know what lenders will say when the appraisal comes back etc. I know what lenders say they will do and then what actually happens.

If the dark value comes in at a point where with down payment and five year primary term   and 25 year amort. forecast is lower than the vacant building value or at then the lender might go for it.  

   

Marylyn,

What is the cap rate going in?  It looks like it is a 7.5 cap rate.  With 5 years left on the lease, you should be over a 9 cap for a good deal.  Is the property in an exceptional market, which would justify the premium pricing?  My firm doesn't do such small loans, but is it possible to get 25 year amortization with 5 years left?  Would the loan be non-recourse?  I would guess not.

Mark

Originally posted by @Mark Creason :

Marylyn,

What is the cap rate going in?  It looks like it is a 7.5 cap rate.  With 5 years left on the lease, you should be over a 9 cap for a good deal.  Is the property in an exceptional market, which would justify the premium pricing?  My firm doesn't do such small loans, but is it possible to get 25 year amortization with 5 years left?  Would the loan be non-recourse?  I would guess not.

Mark

 Yea that is some of my concerns too.  I am actually speaking to the lender today who had already approved it at 3.5%?? I find it hard to believe myself and share the same concerns and questions.  How common are non-recourse loans these days in triple net leases? That obviously is a huge factor.  

To be honest I am not seeing the cap rate with those terms on most properties unless of a poor credit rating tenant.  Have you seen better on triple net leases? If so please share I would love to see them!

Originally posted by @Marylyn B. :

 Yea that is some of my concerns too.  I am actually speaking to the lender today who had already approved it at 3.5%?? I find it hard to believe myself and share the same concerns and questions.  How common are non-recourse loans these days in triple net leases? That obviously is a huge factor.  

Have you signed a loan application with the lender yet?  I find it interesting you say they approved the loan.  Our firm would state that we could consider the loan and we would do a loan application based on verifying terms of the property.  I would be concerned with the short length of lease that is left.  I would also recommend not paying any upfront commission fees at time of loan application.  You will have to pay for third party reports, but if the lender asks for their fee upfront, and it is non-refundable, I would be willing to guess that they will never close the loan.  I had a borrower last year who paid a non-refundable 6,500 deposit on a great teaser rate.  That firm did not close and kept his 6,500.  We did end up closing on the loan which was 22 million.  I believe some BBB tenants have more intrinsic value.  I would prefer a Walgreens over Dollar General , since Walgreen's are usually in better locations, as an example.

Mark

@Mark Creason  

Thank you very much for sharing your experience.  Yes I have not heard of this so it should be interesting to say the least.  The listing agent has the lender in place, but I have not spoken to them.  

Originally posted by @Marylyn B.:

@Mark Creason 

Thank you very much for sharing your experience.  Yes I have not heard of this so it should be interesting to say the least.  The listing agent has the lender in place, but I have not spoken to them.  

 Marylyn, I am looking at similar type of properties, and I find this discussion is interesting. would you like to keep us posted regarding your improvement on this deal?

Originally posted by @Marylyn B. :
Originally posted by @Mark Creason:

How common are non-recourse loans these days in triple net leases? That obviously is a huge factor.  

To be honest I am not seeing the cap rate with those terms on most properties unless of a poor credit rating tenant.  Have you seen better on triple net leases? If so please share I would love to see them!

From everything I have seen you need to be putting 50% down to get a non-recourse loan on a property like this. 3.5% interest rate seems really unrealistic. I would not be surprised if you could get a 70% LTV, 25 year AM and 4.5% - 5.5% interest on a property like this depending on the tenant. You will prob need to hunt around and use local lenders rather than a national lender, but it is possible to get a lender with a 5 year lease left. You will have to be willing to take full recourse on the loan and it will prob depend on your financial strength if they give you a loan or not. Generally a lender is going to want to see at least 6-9 months worth of rental payments of liquidity in your financial statement and likely want to see a net worth equal to the value of the loan at a minimum.

I would spend the time to investigate the property though.  You can find lenders that will commit to doing a loan contingent on an appraisal prior to you need to put money down.  Do your diligence on the property, interview the tenant and try to get a strong understand of the tenant strength.  These days very few tenants sign longer than a 5 year lease so these can just be challenges you have to deal with.

Good luck and let us know how you move forward.

Originally posted by @Tim Shoultz :
Originally posted by @Marylyn B.:
Originally posted by @Mark Creason:

How common are non-recourse loans these days in triple net leases? That obviously is a huge factor.  

To be honest I am not seeing the cap rate with those terms on most properties unless of a poor credit rating tenant.  Have you seen better on triple net leases? If so please share I would love to see them!

From everything I have seen you need to be putting 50% down to get a non-recourse loan on a property like this. 3.5% interest rate seems really unrealistic. I would not be surprised if you could get a 70% LTV, 25 year AM and 4.5% - 5.5% interest on a property like this depending on the tenant. You will prob need to hunt around and use local lenders rather than a national lender, but it is possible to get a lender with a 5 year lease left. You will have to be willing to take full recourse on the loan and it will prob depend on your financial strength if they give you a loan or not. Generally a lender is going to want to see at least 6-9 months worth of rental payments of liquidity in your financial statement and likely want to see a net worth equal to the value of the loan at a minimum.

I would spend the time to investigate the property though.  You can find lenders that will commit to doing a loan contingent on an appraisal prior to you need to put money down.  Do your diligence on the property, interview the tenant and try to get a strong understand of the tenant strength.  These days very few tenants sign longer than a 5 year lease so these can just be challenges you have to deal with.

Good luck and let us know how you move forward.

 Thank you Tim, I passed on that one.  However, I am not seeing great cap rates as others have share- at least not on triple net leases with good quality tenants.  I am still looking!

You just are not going to find NNN quality at a great cap rate in the 800,000 price range for single NNN.

You will deal with local banks and they will want 35% or more down making cash on cash very small.

The upper cap rates you will find just  a little time left on primary lease term or a whopper of a pre-pay penalty on a existing loan you must assume at a higher interest rate which offsets the higher cap they are selling at.

This is why almost all of my clients we are buying strip centers NNN.

I agree with most of what Joel is saying here.  Depending on the tenant you can prob get a loan for lower down payment, but there is real risk.  I agree with him that single tenant is not a great place to start..strip centers are a much better investment. 

I've purchased a large volume of strip centers over the last 5 years and love them if you buy right.  Target properties with a moderate cap rate and some vacancy that you can fill up.  Budget professional property management, tenant improvements, leasing commissions and any fixing any issues that need resolved to bring new tenants into the market. 

My market rules when start out where no less than 2-3 tenant and it had to cash flow day 1.  Not necessarily heavily, but at least something so you could afford to pay insurance and mortgage plus do some repairs. 

I don't know the Maryland market, but I can tell you the Seattle market is very difficult right now.  If you don't have established relationships you have to really dig.  Call TONS of brokers and convince them you are ready to close on a deal.  Get a Loopnet account and look at every property in your investment area.  Spend the time and effort and eventually something will pop out. 

Also, you don't need to be as afraid of mom and pop tenants if you have a bunch of them.  You are going to see some turn over but if you budget for it, that is ok.  Some of my most successful investment have been C Class Retail strips with 100% mom & pops.  I'm selling one center exactly like that right now for 2x my acquisition price in 2012.

One last comment, I try to never buy anything with less than 30% down.  I believe in leverage, but absolutely do not believe in being over leveraged.  The great thing about a retail strip is that with the right leverage, you can handle a downturn in market.  You will be able to sustain some vacancy and missed rents from your tenants coming out alive on the other side.  If you end up over leveraged your risk increasing significantly.  I've been sustaining profits in the 20%+ annualized range for 5 years now.  As the market is getting tighter I'm looking to slow that to 15%+ annualized.

One note about the BBB "ratings"..... all you need to do is give them $500.00 a year to have a rating with them. They call me 3 times a year saying I have made a special list, one time only deal!, think of the possibilities!!!!..... needless to say, I am not on the BBB list.

Cole you are getting things mixed up here. Do not worry this has happened before with other posters on here.

With NNN we are NOT talking about BBB ( better business bureau).

BBB- or better refers to Standard & Poor's credit agency rating for a company. It helps lenders asses risk for giving loans where certain companies are backing the lease and length of the primary term.

Investment grade is BBB- or better. Anything below that can still be credit grade but is considered "junk status". Some companies are not credit rated so they are treated more risky as well for loans.