Triple net leases and buying commercial

15 Replies

So I finally got around to getting my Solo 401k established and have been looking for quality commercial property. I only have experience in multi family and residential so I have been going slow. There seems to be some decent commercial foreclosures available in my market.

I've read a ton of posts about the value of NNN (thank you Joel Owens:) and the typical 5% cap with a corp client is not what I am looking for. I've seen some decent smaller deals such as a newer 2500 sq foot dental office Class A 2005 built in Class A neighborhood. Sold in 2006 for $600k, refinanced for $900k in 2007 bank owned listed at $225k and I have an offer pending acceptance at $165k. Rents for such spaces command $1.5/sq foot so the cash flow should be decent with eye on future cap appreciation.

Question for all you commercial investors ... what do the good deals look like? Please share some of the better deals you have made and some that did not work out so well. What is your main source of finding these deals? What are some of the major pitfalls to look for in DD?? Look forward to hearing from you.

Question for all you commercial investors ... what do the good deals look like?

Serge, this is what a good deal looks like:

I've seen some decent smaller deals such as a newer 2500 sq foot dental office Class A 2005 built in Class A neighborhood. Sold in 2006 for $600k, refinanced for $900k in 2007 bank owned listed at $225k and I have an offer pending acceptance at $165k. Rents for such spaces command $1.5/sq foot so the cash flow should be decent with eye on future cap appreciation.

Seriously, you should be telling us!

Thanks Jon! Keep in mind that the space is not currently leased. The dental practice claimed bankruptcy, and pulled all the chairs and equipment out. So there will be some capex involved. Not sure if a prospective tenant will expect it fully built out or will be happy bringing in their own chairs, equipment, etc.

I also expect a long vacancy as everything I look at that is available takes a long time to close. I'm talking 3-18 months.

It gets me thinking about commercial vs residential. Seems that you can always squeeze a 10%+ cap out of a good residential buy while people seem amazed when you talk that kind of cap with commercial.

To get a good commercial deal requires assuming the risk of vacancy, build out, etc while a good residential deal will require rehab and tenant headaches.

End of the day I'd like to be in both albeit with high caps both ways. I'm not in a financial position to take down the proverbial NNN Pharmacy at 5%. Thus I'm concentrating on the vacant REO with the risks noted above in exchange for the cap I'm looking for.

Would love to hear the numbers on some other commercial deals you guys have been able to close.


Your initial question and your response to Jon's input shows you are on the right path in analyzing risks associated with commercial properties.

If this is an office condo unit, then you have to factor in the POA costs, leasing costs, insurance costs, etc. Most office leases are gross leases, with landlords utilizing a base year for escalations. If this is a stand alone building, then a true NNN lease is possible; however, you do have to compete in the market place. You might want to look at the competition and the absorption rates to help you calculate vacancy costs.

Why did the previous owner fail? Could be that many dentists saw a reduction in visits because of the downturn in Metro Phoenix. Was he a poor operator? A lot of competition? Overbuilding in product type?

I may be showing my age; but, many deals were done in Texas in the 80's when Landlord's were begging for tenants. Commissions were paid, Tenant Improvements paid for, free rent given; and, in the end the tenants bailed after the free rent period. The RTC days were no better.

Class A properties in office can be found on Central Avenue, Camelback (east) and Scottsdale Road, offering unmatched locations, amenities, and prestige. Class A, outside of these areas is a misnomer. If you have a "B" or "C" location, it's impossible to have a true Class "A." building.

If you are looking for commercial, there are numerous brokerages in town that will help you locate and analyze the asset, the competition, and the costs associated with ownership. The seller usually pays the commission. Search for a firm with a good reputation and experience in your sub-market.

Good luck!

@Paul Falbo Thanks for the wisdom. I don't yet have much insight as to the reasons for the past owners failure. Buying the property for over $500k and refinancing at $900k certainly could not have helped.

I am in touch with local brokers although I'm not sure I've found the right one just yet. Any chance you have an east valley referral for someone knowledgeable.

I have been using MLS data for comps, rental rates, time on market, etc but I know that a lot of commercial space does not run through the MLS.

It is not truly standalone but in complex of office buildings primarily medical space. By your judgement it would be Class B, I can't imagine it being class C though. Looks like lease rates do go as low as $1/sq at time but do average closer to $1.50. I really hope to not have to re purpose the building and incur capex.

P.S. I arrived in Phoenix in '88, when foreclosures were at an all time high. Those people that were able to purchase REO's made quite a return in a few years.

Things are a little different now, with internet retailing and telecommuting, the dynamics of office, industrial and retailing are changing. Just look at the vacancies in retail centers, office buildings, and warehouses.

The good news is that new construction isn't happening, except in exceptional cases.


Good point. Seems like the cycle repeated itself 09-11 and with residential clearly rebounding you would think commercial and land are not too far off.

I remember in 09-10 nobody was buying land (aside from a few of the smart builders buying in price locations). Now I'm seeing interest in land and while everyone is still chasing SFRs for at a continually compressing cap rate a lot of commercial deals are not being noticed. Particularly the ones too small for the big guys. As you said risk/reward. My take has always been to take what the market gives you.

It sounds like an office condo. You might find that the CC&R's for the association punitive if the project has a high vacancy or foreclosure rate.

Well, at least you're buying at a good price. I don't know much about the AZ commercial real estate market, but $66 per sf in your market may not be such a great deal. I did a quick search on loopnet and saw that you're going to have a fair amount of competition in the medical office arena. I'd guess that you're going to have to hustle to fill this space. I don't think you can get around throwing in some serious TI money or doing a refurb/upgrade etc on your own.

Commercial spaces are not like residential. Everyone needs a roof over their head. No one needs a commercial space however. When times are good, the money in commercial is also good, but when times are bad, the dollars are few and far between.

I'd take a good real hard, pessimistic look at this place to make sure that your assumptions on rehand and rent are realistic.

@John Mireles your thinking mirrors my own. Hence all the questions ... I agree that the deal looks much better on the face of it than it probably really is. Diving in to commercial has really got me thinking ... why go commercial over residential?? I clearly understand the deep pockets that want the consistent returns of a NNN lease to a corporate client but what about the mom and pop investor? I so rarely see commercial deals that can replicate the returns I get with residential. The thought of having a property on the market for over a year and huge tenant build outs makes me really wonder how its all worthy. I'd love to hear success stories from some of you commercial guys. Has anybody successfully transitioned from residential to commercial and was it worthwhile??


I own two commercial properties and two residential properties. I've been trying to lease one of my commercial spaces for two years now with no luck. My residential units rarely go two weeks with a vacancy. Going forward, I'm sticking with residential.


@John Mireles How is the other commercial space doing? If you don't mind it would be great if you would share your numbers and experience with both the commercial spaces.

Hi Serge,

The pharmacies are mainly a tax asset and future income stream for retirement. Those loans are non-recourse and you can get a new loan with a BTS or buy in and assume the loan with an equity down payment.

Now there are value add plays where instead of a 5 to 6% cap there is say 5 to 10 years in the primary lease. You can get those at a 9 to 10 cap return. The problem is you are paying cash (millions of dollars) or to make the financing work you are having to pay a ton down 30 to 40% so that the loan is zeroed out when the primary term ends. The pharmacy renew over 90% of the time but a lender doesn't want to take that risk. There are shorter term financing for bank loans on the pharmacies but then with no increase in rent bumps in the primary term you run the risk of the loan coming due before primary term ends and be in a negative cash flow situation.

Banks, restaurants, dollar stores, auto stores throw off annual rent bumps in the primary term and caps can range from 6 to 10% starting. Now with Mcdonald's those trade at crazy 5 caps. Foreign investors buy those for cash and a investor getting a loan the amount down to make the DCSR work doesn't make sense.

An Applebees for example you can get a brand new 20 year lease for asking of say 2,400,000 and the starting cap is a 7. Has annual rent bumps built in of 2.25% with DSCR of 1.25 you are typically putting 25% down. Cash flow increases every year with the bumps and equity build up occurs from principal pay down. You don't have to worry about tenants, toilets, and termites no living up to their agreement. This is for a corporate store guaranteeing the lease. Of course with a franchisee you have to look at many other things as the risk is greater but usually rent bumps are 3% a year and cap is higher starting off to compensate for the risk.

Soon I will start a BP blog on NNN investing.

Mom and pop type value add for NNN I do not get involved with. The price point is too low, a bunch of messes to clean up to close the deal, lot's of time involved and low return, and financing is harder to get.

This is just like vacant apartment buildings. I do not do those anymore also. After spending months and months negotiating water liens, and multiple loans etc. and the units needing total gut rehab making an 8k return is too small.

I can just as easily work on semi-performing apartment buildings or fully performing and put the same time in and make a much greater return for my time.

So for 2,400,000 25% down is 600,000 before legal and closing costs and due diligence. Usually my clients that want to buy this type of property want less risk and to get a happy yield but do not want to take on a job. The type of vacant NNN mom and pop type deal is a job where you will have to be hands on to get it performing again. Most of my clients barely have time to breathe they are so busy and just want something that goes and they collect a check.

You can find small NNN deals sometimes like a Pizza Hut for 300,000 at a 10 cap or things like that. The more urban areas and markets like Cali or New York the caps get compressed further. The suburban markets with strong demographics is where many of the good buys are. The big institutional buyers in the urban areas most investors needing to get a loan with some down will not be able to compete with all cash and a quick close for those trophy locations in the urban core.

@Joel Owens Thanks for chiming in. I definitely understand the benefits of of the large stable NNN play. Unfortunately that's not the investment that works for me right now. I get all the negatives you mention about the small commercial deal and for you as a broker clearly the bigger deals make that much more sense.

But ... playing devils advocate and taking the approach where I am comparing a mom and pop commercial deal as you call it to residential. You say the returns are lower while the work is higher, is this really the case?? Considering commercial property is basically a cap rate function of the lease and that unoccupied space is discounted 20%-40% due to the lease up and capex risk, if the numbers work then I see how it could be a really decent niche.

Say you can buy medical commercial space, 2k sq feet unoccupied distressed with rent rates of $3k net monthly with little necessary build out (not a shell space). At a 10% cap and leased this building should be worth around $300k. If you can buy it for $150k and have the cash reserves to stomach the lease up risk (and capex) then I would see this as a great alternative to a $150k house that rents $1500.

Also I see some upside in capital appreciation. Whereas residential will most like see modest appreciation (my market at least), I see this class of commercial still having a lot of room for upside. I think at the end of the day the comparison of this smaller commercial play to the true NNN larger investment is not a fair comparison. I'm more interested in comparing the smaller commercial purchase to a residential SFR. Definitely different but in this market I think it may make sense and be a niche worth exploring.

Sure at the end of the day it is about work in for return expected and time needed to get the desired outcome.

If the project pencils out as you say then it can be a great deal. You just have to make sure you can get that 3k. With commercial there are graduated leases and tenants would like to lock in rates that do not go up but every few years. This is especially true with smaller businesses watching every penny.

I understand what you are doing and it can work versus a SFR.

OK this may be a funny way of analyzing whether its a good deal or not, by seeing if equity capital would fund your project. They would analyze the deal with you in mind because everyone would have skin in the game, and if they would join in investing, it would cut your risk in the investment and the gain, like having a partner. So their experts for instance would likely determine if the property was currently viable in the marketplace or whether maybe it needed conversion, and maybe they would invest in that right along with you. Equity capital allows you to play bigger in the game and would allow you to remain in control as the principal.

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