NNN sale-leaseback opp. - need help!

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NNN sale-leaseback opp. - need help!

Sam Malhot
Livingston, NJ · Member since 2008 · 2 posts · 0 votes

Hi, very new to CRE investment, but I have been getting up to speed quickly. Anyhow, ran into a potential opportunity for a NNN investment, but feeling very unsure about my analysis and what to make out of it. Therefore, I am posting it here for some advice.

A financial institution with ‘Aaa’ rating is looking to sell / leaseback their existing locations in my area. They are asking for offers based upon MAX 6.5% cap rate. In seller own words: Buyers are encouraged to submit offers based on cap rates that are significantly lower than 6.5% to ensure the competitiveness of their overall bid. Additional consideration will be given to those bids that allow for additional lease flexibility within the portfolio (lease termination rights, expansion rights, etc.)

One Sample property:
Building: 3420 sq. ft.
Lot: 32670 sq.ft.
Rent:
Year 1-10: $55,000 / Yr
Renewal terms: 4, 5 year options @ 15% Increase.

If you go with the seller directions, they are asking for $846,153 (6.5% cap) or $916,667 (6% cap)

My Concerns:
- Locked into long term lease (30 yr) with no rent increases for first 10 years, therefore no real appreciation potential for a long time.
- Most of the locations can be defined as second- or third-tier location (i.e., a block or so off the main retail drag). Most would be considered "location-challenged", in the sense that it can only accommodate a similar business and cannot be converted to a general retail-commercial space.
- Given my AGI (150k+), I believe I can’t take advantage of tax benefits, making it harder to justify the deal. Is this correct?

My questions:
- With NNN leases, is it as simple as it sounds, i.e. landlord does not have any expenses, so your Gross = NOI? In other words, the only exp is debt service?
- Based upon my understanding and a say 6% Cap, even with no expenses and 20% down ($183,333) the yearly payments alone one a $733,334 loan (6.5 %, 20Y) will be $65,610 making it $10,610 neg. cash flow. What do you think will be a fair price?
- I can dig more deeper and look for potential tax benefit, appreciation and equity buildup benefits, but at the end of the day it is –ve cashflow. Ho will you factor in those issues?

Sorry for the long post and lot of q’s. Thanks in advance for your help!

Sam

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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    18y

    Unless you can get a higher cap rate than your loan rate, its a non-starter. Value of commercial is determined by the rent and cap rate. As you point out, you have no increases for 10 years, so there will be no appreciation.

    NNN properties are often purpose built. Finding another tenant when the lease ends may be impossible. Just drive around the country and look at all the empty Wal-Mart hulks or Pizza Huts. So, the improvements may have little value except to the current occupant. You should assume the value at the end of the lease is the value of the land.

    This seems like a really bad deal. You invest $183K and lose $10K a year.

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  • Greg Schickedanz
    Real Estate Broker · Highlands Ranch, CO · Member since 2008 · 95 posts · 23 votes
    18y

    Sam,

    A couple thoughts:

    1. Of course the seller wants "competitive bids" - but in reality they may not get any bids! If so, a higher cap rate will be justified when they decide to get serious. If you really want them, why don't you prime there thought process with an offer of 8 cap with 2% annual increases!

    2. NNN has been a very loose term of late. You need to make sure it is "absolute" NNN and the lease spells out how the tenant pays for everything - including taxes and insurance, maintenance, repair, etc. I've seen plenty called NNN and they really aren't even close - so read the terms carefully. Absolute NNN means the tenant pays all of the costs DIRECTLY (they are not even reimbursable expenses).

    3. Be sure of what they are selling - I've seen some on ground leases that aren't a part of the sale - so you could end up holding zippo for real assets - unless you plan on moving the building!

    4. Consider seeking financing that offers a longer amortization period - 30 to 40 years with a balloon - the key is to balance the cost vs return to your highest advantage.

    5. Tell me what part of the country you are in - I track the NNN market and nationwide there are over 140 available at 8 to over 10 caps - all with an average of over 15 years remaining on primary terms, all with extension options, all with 1.5 to 2% annual or worst case 5 to 10% rent bumps every 5 years. You could likely do better with something else!

    6. The only ones buying low cap rate properties are the cash, safety investors (insurance companies and some REITs) - let them have them, they'll get buried just like sub-prime and Alt-A! When the 10 year Treasury rate moves up (trends solidly and with momentum) and it will have to someday, the question is when - the cap rates will follow and no one will want those 6 caps!

    Keep us posted as to your progress!

    Let me know if I can help!

    Broker/Owner

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  • Sam Malhot
    OP
    Livingston, NJ · Member since 2008 · 2 posts · 0 votes
    18y

    Wheatie / Greg, thanks for your insights, some very valid points.

    Greg, I agree with your sentiment, today 10 yr. treasury is up to 4.10, highest we have seen in a long time. The interest rate trend is looking to move up, indicating higher borrowing cost and cap rates. But, then again who knows where we will be 10-20 years from now.
    The opportunity is in northern NJ, a very competitive market, very hard to find anything commercial above 6-7 % cap.

    Anyhow coming back to the deal:
    - Even at 6.5 cap with 20% down ($169,231), the debt will be $676,932 (6.5%, 25Y), requiring a $60,563 debt payment, making it –ve $5,563 cash flow for the first 10 years. But assuming the tax benefit (39.5 yr dep.), principal reduction and appreciation (3% YOY), the return on initial equity ($169,231) is about 25.63%. Does not this sound reasonable?
    - Another Q, given the standard debt service coverage ratio of 1.25, on a $55,000 NOI, a bank will offer a loan of $543,043 (based upon max $3667 P&I (55000/(1.25*12)). So in theory, I will need to put more down or carry a 2nd. Making it even harder to do the deal. NO?
    - I can redo numbers with a 30-40 year with balloon to keep the debt payment down in the beginning years, but by doing this, does not I am simply trying to justify the deal at seller terms?

    Thanks for all your help, this is very informative.
    Sam

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  • Account Closed
    Real Estate Investor · CA · Member since 2008 · 81 posts · 0 votes
    18y

    There are other lenders that do NNN lease. They will be more than happy to explain how they fund.

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