This is exactly why I tell my clients not to buy these low cap properties.
If it has the parent corp. guarantee at least you have that revenue stream but if a franchisee guarantee you can be in trouble. even parent corp. guarantee at a low cap doesn't make sense.
Stuff trading at 4 caps for 2 to 3 million for a Mickey D's is scary. I just saw Longhorn Steakhouse today for sale.
4.4 cap rate at 6,800,000 with 1% annual increases. This stuff is just frankly nuts.
Can you imagine buying debt with short term 5 year loan on these properties?? You got to sell or have to refi and the interest rates are higher.
The higher cap rate or value add gives you more flexibility on the exit.
To add to your point, many fast food companies have highly specialized buildings, often in locations with low land value. So if the tenant leaves you are often stuck with an asset that's hard to rent or sell.
That said, I do think there's a place for NNN national credit tenant investments. They're just not the risk-free money that people seem to think they are.
Yes triple net and retail is what I specialize in along with larger apartment buildings. I usually review hundreds of properties a week.
Some of these restaurants are trading at 600 to 1,000 sq ft. The second or third generational tenant will not come close to those rent levels. That is why newly minted 20 year primary term lease with corporate guarantee are so sought after with low caps. I am finding investors massaging the debt with short 3 to 5 year loans to make it cash flow. Those are ticking time bombs.
I would much rather own a triple net strip center sitting on more land at 125 sq ft at higher cap rates. That's just my personal preference for a number of reasons. I do have clients that bought single tenant buildings 3 years ago but the market is really frothy now for my liking. Many of these properties at such low caps with debt have very little cash flow at say 5% a year. Basically you are getting principal pay down build up and I do not see anymore cap rate compression.
My clients that bought at an 8 cap 3 years ago can now sell at a 5.5. If the investors debt matches the length of the primary term with a set interest rate and it cash flows and the cap can be blended upward over time it can be still a manageable investment.
Sure non-bank lenders are more expensive. You are also getting non-recourse with standard carve outs.
People that are worth 5,10,20 million net worth care about non-recourse. Their other investments if they had to lose half a million eventually on a deal worst case scenario to get out they would be okay. What they wouldn't want is full recourse against them on the 4 million debt for example dragging down other investments and them personally.
Also you have leverage in non-recourse as the lenders only action is to take the property back or want to do a workout. Trying getting any concessions from a local bank on recourse. They don't care you are losing 5k a month. You pay or they come after you.
So while non-bank money in fees might be tens of thousands higher to me to get better amort., longer loan term, low fixed rates, and non-recourse is well worth the extra up front costs involved.
There are still value add deals in single triple net properties. One strategy is to buy a pharmacy cash with 4 years left on the lease for example as financing is hard to do under 10 years left. Then you negotiate for renewal and keep rent flat if they up early. Now you have a 14 year lease if they sign on for another ten years.
You bought at a 9 cap and can now sell with a 14 year primary lease at a 6.5 cap and pocket the cap compression spread.
That is an excellent strategy that I had never thought of. Thank you!
Oh the lovely NNN leased investments. I've never sold (or bought) single tenant NNN deals, but I've been involved in some larger NNN leases for other types of properties, mainly industrial food processing and cold storage.
I've always found it interesting the buyers of these properties are more focused on the term and credit strength than they are on the actual property. Of course rents also must justify the investment too. These buyers were using institutional capital, and or their own publicly funded capital so their not investing like your average HNW individual chasing a combination of yield and/or security of capital. That said though, I'm gathering from this thread that HNW investor also are more concerned with the yield and less so with the resulting property left at lease termination.
As an investor I do not have a direct interest in any one NNN leased investment, but do have exposure to this asset class through a REIT stock of a REIT going through a transitional phase.
I can't tell you how many larger industrial functionally obsolete buildings I've walked through that were former NNN leased investments. I can only imagine how a small single tenant NNN building would have a hard time replacing a tenant after the original tenant vacated the property.
Geez why bother with these and the risk and all the hassle when you can plunk down that money in a mutual fund and get 10-12% and lay on the beach somewhere. Is it just me or is this insane?
Geez why bother with these and the risk and all the hassle when you can plunk down that money in a mutual fund and get 10-12% and lay on the beach somewhere.
If only that were true.
One of my most recent closings is a mid development deal for a strip center. Off market and my client when finished will have millions in upside. Developer had too many developments in process so took some profit and focused on other deals.
Another client of mine bought a pharmacy in 2012 for a 8 plus cap. Could now sell in the low 6's and with cap compression has about 800k equity gain not including principal pay down.
Lot's and lot's of reasons commercial real estate works but you have to know what you are doing or get with someone who does with your capital because like anything else you can also lose your shirt.
This listing near me illustrates just what you're talking about. Non-corporate KFC in a specialized building with a 6.5% cap, 12 years on the lease at 1.5% increases starting 2017 and some options.
Just out of curiosity I fired up Excel and used some assumptions that (1) the land value will gain 1.5% per year in line with the lease, and (2) the lease will terminate with unexercised options and no improvements value. The unleveraged IRR at the asking price is just 2.36%!
The only way you could see any reasonable return is if the tenant exercises at least one option. Then you finally break a 7.01% IRR over a 22 year period.
But it says right in the listing that the tenant already renegotiated during the last downturn. So when re-up time comes and they know they've got you over a barrel, you can bet they'll do the exact same thing. And even your paltry 7% flies out the window...
KFC's have been on the down hill for awhile.
Unless you are in a high frying type state they have been suffering.
Non-corp at 6.5% is a joke. That is reserved for parent corp guarantee and 1 to 1.5% is corp. as well.
What constitutes a deal is based on the dirt, remaining primary term of the lease, who guarantees the lease, and blended cap rate with annual increases.
The only winners for these NNN lease assets are those that build them and sell.
I remember reading somewhere that McDonalds is a "real estate company", rather than a restaurant company - I was surprised to hear this, whatever it means. I guess the intent of this is real estate is an important part of their operations. They seem to be able to have the best locations, and these locations often become more valuable over time. Their locations are a key point if building and maintaining volume sales.
Yes they do hold real estate but sold a lot of it off in the past years.
Just today a recent article came out touting Mcdonald's troubles. Mcdonald's used to build on 3/4 acre lot's but when land became more expensive they moved to 1/2 to 1/3 rd acre parcels to develop on.
The problem is if Mcdonald's ever goes dark and I am sitting on dirt value that isn't worth the loan and building mortgage balance. There are not many tenants that can fit on a 1/3 of an acre space but there are much more that can fit on a 3/4 to 1 acre space. So I am either limited on re-leasing the as-is space or I have to try to assemble other buildings or land next to me which might not even be possible and if it is it will be expensive in most cases.
Mcdonald's are trading at 4 . 4.5 cap rate which is just insane. Especially if it is a franchisee and not a corporate store. About 80% of Mcdonald's are franchisee stores and they are trying to move it to 90% to offload operational costs and risks. It seems they might not want to shoulder possibly paying people close to 15 bucks an hour minimum wage to flip burgers. If that does happen look to restaurants to automate functions with robots and machines and reduce the employees.
The recent article said Mcdonald's sales are down another 2 plus percent for the most recent quarter. Here is the problem I see with Mcdonald's. Prices of beef are going up. Shake Shack, Cheeseburger Bobby's, and other burger concepts are new and fresh to consumers and they use much higher quality beef. Before Mickey D's was cheap in price. Now that they have raised pricing for the junk meat they call a patty for a few dollars more you can get a high quality all beef burger from elsewhere. So the only thing you might be saving is not money really but time through a drive thru. The franchisee confidence score is close to a 1 the lowest it has been in decades. This score is how franchisees feel about the job Mcdonald's is doing and the direction of the company. The article did say it was a very small sampling but I have read other articles that say franchisees are not happy with the current situation.
I just do not know long term if they can survive without changing their business model from a frozen to a fresh concept. Everyone is trying to go fresh these days and use less preservatives. It tends to taste better for quality and have less chemicals. I am not recommending to my clients to buy Mcdonald's at the cap rates they are selling at right now. It just doesn't make sense. Some foreign buyers like them because price is small 500k to 1,500,000 or so and they pay cash. If they get 4 to 5 % it's better than the 1% sometimes they get where they live overseas on their money.
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