Location vs Leaseterm/cap

8 Replies

I was looking for the past while . I noticed a few decent deals, but I find anything 10+ years and with a decent cap is mostly located in remote rural areas.  How important is location?  Is it worth pursuing these deals? Or should I wait for something to come up in more populated locations?

The major thing I'm seeing is that nationally recognized tenants, such as fast food chains, pharmacies, dollar stores and regional grocery chains don't really yield a cap over 5% or don't have a lease more than 5 years.  Unless you go to smaller rural cities.  

Hi Jay,

You are not looking in the right places.

It sounds like you are only looking at STNL (single tenant net lease ) properties.

The best time to buy those was 3 to 4 years ago when it was just recovering and cap rates were high. It has compressed but still good deals to be had today. People think STNL is easy and simple and that is not the case. I specialize in it everyday and there is a lot of due diligence required before making a purchase.

Urban core is compressed but still value in strong suburban areas. I would stay away from rural locations. The value is tied only to the lease with very little compensation to the dirt so once that period is over the second generational tenant will likely pay much less than the first. 

The total scope of information is not possible for me to share in this post as I would be typing for an hour. I talk to people on the phone all the time about what can be purchased for what at this point in the cycle. Investors objectives vary based on age, legacy goals, risk tolerance, return focused on cash on cash or equity growth, etc. Tons of variables.

Hope this helps. 

I forgot to mention while cap rate is important where the lease rate is going can be more important sometimes.

Example a cap starts at 5.75 but has 1% rent increases. Another property with the same quality has 5.30 cap but 2% annual increases. Over time the blended cap and return will be higher with the lower cap rate to start.

You have to consider where it is today and where it is going tomorrow. You also have to underwrite the strength of the brand. I use 5 levels.

Taco Bell owned by Yum brands.

Top guarantee:

1. Yum corporate covering thousands of stores.

2. Yum subsidiary - covers says 250 stores in one state for example

3. Large franchisee - has hundreds of locations and a great operator for 15, 20 years etc.

4. Small franchisee - owns 1 to 2 stores

5. Not even a Taco Bell concept or franchisee but a startup ( joe's taco's ). 

Awesome, Awesome input Joel. You're right I was just analyzing STNL's with NNN. I thought it would be the best option since I was going to be an out-of-state investor and it would require minimal management. I've been looking at other types of properties but they more management intensive.

Another thing I notice is that these structure's are too specific to the tenant.  So if they decided to vacate it would be costly to renovate.  Plus some of these stores, especially Dollar stores use cheaper metal frame construction.

To your point of investing strong suburban areas, I personally thought these areas in and surrounding major metros are dominated by large investment groups and it would difficult to enter this space.

Sorry forgot to ask, about rental increases.  It was my understanding that these are always negotiable and sometimes the landlord can't always exercise the full the rental increase but sometimes can only get partial. 

Hi Jay,

With STNL's there is not any management on a truly NNN property. You just collect the check. Retail strip centers there is some management with a PM company although they are also NNN. You have base rent plus CAM on those type properties.

If an STNL and a NN lease then you still are responsible for roof, structure, parking lot, utility lines, etc. ( it varies when the lease was created what was written in ).

If NN lease I want to see a 75 basis point premium in the purchase price or higher to offset the NN versus NNN.

The primary lease term the rental increases cannot be renegotiated and they have to pay it. Having said that if it is not a corporate guarantee but a franchisee they might be struggling and say they need a rent decrease or stay the same in the primary term. You as the landlord do not have to agree to that and can request audited financials showing sales levels. I like to see 10% or lower of the annual rent to sales level. You would want 100,000 or less rent annually based off of 1 million in sales. Preferably 6 or 7% is better. I also look at if their location is under, at, or over performing for that brand concept. If there truly is a hardship then you have to decide what kind of workout if any you want to do in amending the lease terms.

Dollar stores were a deal 3 to 4 years ago. Today overpriced junk in my opinion. They used to do 10 year lease terms with rental increases every year and you could get 8 to 9 cap. Now the new leases are 6 to 6.5 cap and no rental increases in the 10 year primary term. The locations tend to serve middle class and lower areas where the dollar stores thrive in sales and the value of the dirt isn't worth as much. They also put in commercial areas but most times not close to corners so the second generational tenant will not pay the same lease rate you were getting before.

On the stores if you get a box they are easy to re-image. Things like Sonic, Checkers, etc. are much harder to do anything with. 

Jay I would have to discuss on a call to see what might fit your objectives and plans. I do business all over the U.S.

Retail is what I do day in and out.