How does financing work on NNN investments?

Question

In the NNN world what does typical financing look like?

i.e. What are typical term lengths? What are typical interest rates? What is a required minimal lease term remaining on NNN tenant? What is minimal amount of loan in order to get non-recourse debt? What is the typical required down payment percentage? What is important in a loan for a NNN property that I am not asking about?

Joel Owens · Answer

Hi Todd,

Are you looking to purchase or is this for a client of yours?

Are you doing a 1031 exchange?

What is you or your clients timeline to purchase? The STNL debt markets are constantly changing. I assume you are talking STNL only and not also MTNL (retail buildings) correct?

Those are 2 very different asset types underwritten in completely different ways from a lender and an analysis standpoint.

Financing depends on a ton of factors that can vary property by property.

You have:

1. Deal size (2,4,6 million etc.) where cap rates available and debt rates can change. Bigger property then generally less buyers (smaller pool) so can get a better cap rate. Additionally generally better debt rates as many lenders want to compete on 2 million dollar loans and above. Loans below 1 million the specific STNL lenders tend to pass on. The loan is too small for them to service or deal with selling off or the location is too weak for them. ( They can make exceptions sometimes for something like a Dollar General in a weaker market that is investment grade and a low price point).

2. Location: (Rural, weak suburban, strong suburban, urban core). The further you go into weaker markets the more lenders fade away and you are left with local banks and credit unions where loan terms are not that good so have to buy the property at a really high cap rate to try and offset risk more.

3. Credit of the tenant: You have Standard and Poors investment grade tenants BBB- or better. Usually they have the lowest default rate historically percentage wise of public traded and rated companies so lenders tend to give the best loan terms on them. The leases are generally backed by thousands of locations as well.

Below investment grade you have credit rated tenants but not investment grade. As the grade moves down the spectrum the default percentage rate goes up by the S & P ratings system so lenders compensate by requiring more down, shorter amortizations , etc.  You also have larger private companies that have always been private or they were once public but were bought out by an equity group. Some lenders have internal ratings systems on private tenants even though they were never public or have now gone private and will still give competitive loans on them.

An example of this is Red Lobster that used to be under the Darden corporation investment grade tenant but was sold off to a private equity firm. Generally the lenders want to see individual store location unit sales and then the corporation overall financials.

In addition you have what I call my 5 levels.

Yum brands for instance owns Taco Bell

You could have in the lease strength from best to worst:

1. Yum brands corporate guarantee backing all the stores

2. Yum brands subsidiary where say 15 states worth of stores are backing the stores lease you want to buy

3. Large franchisee of Yum brands that owns 100 plus stores and in the system for over a decade as a proven operator.

4. Small franchisee that as 1 to 2 locations and newer to the system or marginally capitalized ( hard to get lender loans on those properties)

5. Not a Taco Bell just a mom and pop concept with little to no marketing budget or system outline. Could go boom or bust.

______________________________________________

4. Length of primary lease term. This makes a big difference in available financing with lenders. generally they will not touch anything below 8 years remaining on primary for the best terms. Lenders do not count the option periods as those are not a given. Also you have to watch out for no guarantee on the lease, a corporate guarantee for just the one location where they can easily remote bankrupt it and walk away, a parent corporate guarantee that burns off in the primary lease term of 15 years only 5 years in, a parent corporate guarantee that transfers to a weaker franchisee after so many years of operation in the primary term, etc.

For non-recourse debt lenders like investment grade tenants. Minimum down is 25% in some cases but most of the time 30 to 35% down. Lenders do an appraisal for current value and then dark value on the lease with no tenant and income in place. They want at end of the lease term for the loan value to be lower than the dark value so if tenant does not renew the option or you can't find new tenant then they can foreclose and be made whole on the loan liquidating the property. This is why properties with less than 8 years left on primary the lenders like extra large down payments and lower amortization repayment periods to accelerate the mortgage balance paydown.

I hope I answered your questions on a basic level. I am a specialist in the space reviewing about 1,000 properties a week for clients nationally.

Joel Owens · Answer

Hi Todd,

Yes 1 million price is tough. In commercial real estate it is like a 50k house in residential. The location usually isn't there as it's rural to weak suburban and credit of tenant is non-existent. The local banks then typically want 20 year amortization on a long time remaining on primary term of the lease and at least 35% down.

Sometimes you can land a ground lease in a strong suburban area because rent cam sometimes be half of a regular NNN property with land and the building. You do not get any real tax depreciation benefits but can own in a 3 million area for 1.5 million price.

Potential clients that contact me in that low price point either decide to stick with residential for the 1031 exchange, exchange into a TIC or DST of a larger property they could not afford on their own if they qualify, just pay the taxes and not exchange if small amount from their CPA analysis, or they get a friend or colleague to go in with them and add money to their exchange.

I have clients that do that and instead of buying in the 1 million range they buy closer to 2 million price with a partner. I have remnant buyers in my database that contact me to purchase but their capital is too low. They want to own directly on stabilized assets so sometimes I introduce these buyers and they combine money and then have me go look in a larger price point to get the quality of tenant, location, and lease that they want.

If they are a remnant buyer and not a 1031 then I offer them my value add syndicate I do for retail deals where I am the sponsor.

Joe Villeneuve · Answer

Direct from the Master

Joe Villeneuve · Answer

...and the info just keeps getting better.

Todd Willhoite · Answer

Thank you @Joel Owens that is exactly what I needed to know.  Looking to purchase on a 1031 deal, but looks like only a $1 mil deal.  NNN probably not a space to look at until in $2 mil range, so $500k + down payment.

How does financing work on NNN investments?

Most Popular Reply