Triple Net Analysis: How to calculate expense

16 Replies

Question for you all concerning the analysis of a triple net property.

I'm working with a client who's interested in a 6,000SF office space set up for medical spaces. I've researched average per sqft rent (16.50 / SF / year) and I can run mortgage calculators no problem. Where I struggle is estimating expenses. With a triple net lease, I understand that the tenant pays tax, insurance, and maintenance. Sooo what does the landlord have to account for?

To help me out let's assume gross income is 100k / yr and a 4 CAP. What can I expect the expenses to be? (from there I can calculate NOI and property value)

Thanks in advance! 

If it is an absolute NNN lease, then the landlord should only be responsible for accounting fees (tax prep) and legal fees.

Also, you want to read the lease to see if the landlord is responsible for any capital improvements. If they are, you might want to add a capital reserve expense to your underwriting although its not a true operating expense i.e. capital. If its a 4% CAP, I would be hard pressed to believe landlord has any responsibility.

Originally posted by @Courtney Duong :

@James Storey and @Joe Villeneuve what about property management fee? For absolute NNN, do tenants pay for property manager too or only tax, insurance, and maintenance? What if the landlord is doing in house property management? Thanks.

 What property manager are you speaking of?  The tenant (franchise) IS the property manager.

@Courtney Duong yes the tenant can be responsible for property management as well but it's not always apparent. If the landlord wants to hire a property manager to operate the property, he certainly can do so but for underwriting purposes it wouldn't be applicable to determine the value since a majority of investors buying single tenant absolute net leases will elect to self manage since they a merely collecting a NNN lease check and depositing it into their business account. If a NNN property had more robust CAM expenses that a landlord had to manage and bill back to the tenant and multiple tenants, then a property management fee would be more applicable.

Originally posted by @James Storey :

@Courtney Duong yes the tenant can be responsible for property management as well but it's not always apparent. If the landlord wants to hire a property manager to operate the property, he certainly can do so but for underwriting purposes it wouldn't be applicable to determine the value since a majority of investors buying single tenant absolute net leases will elect to self manage since they a merely collecting a NNN lease check and depositing it into their business account. If a NNN property had more robust CAM expenses that a landlord had to manage and bill back to the tenant and multiple tenants, then a property management fee would be more applicable.

Well said

 

@James Storey we are looking at a potential purchase (retail, multi-tenants). It's NNN and we plan to self-manage it, that's why I asked because I am not sure if tenants will be responsible for paying our property manager or not.

@Courtney Duong If the leases permit the tenants to pay for property management and you decide to self manage, you can charge the tenants for you to manage the property. Not all NNN properties include property management which is why I never include it in the expenses on these types of investments until later in the due diligence. If after reading the leases you determine that the tenants are responsible for property management, you will need to prepare a property management agreement with those tenants to determine how much you want them to pay. Keep in mind that the more expenses you create for them, you will make the space less and less desirable at future renewals so I wouldn't go overboard with charging them. I have a lot of clients that do this as well.

The calculation for calculating NOI for a NNN leased property is a follows:

Rental Income

+ Reimbursement Income (Tenant reimbursing the landlord for operating expenses)

= Subtotal

- Vacancy/Collection Loss (% Applied to the subtotal)

= Effective Gross Income

- Real estate taxes (Typically reimbursed in a NNN lease)

- Insurance (Typically reimbursed in a NNN lease)

- Maintenance (This will depend on if single-tenant building or multi)

- Utilities (Could be nothing is single-tenant building)

- Management Fees (Typically reimbursed in a NNN lease)

- General/Admin Expenses (Typically reimbursed in a NNN lease)

- Reserve for replacement (Tenants do not typically reimburse for this)

= NOI

NOI/Cap Rate = Market Value

Gregory it's all about what IS IN the lease. The OM's and sale flyers are often completed by virtual assistants or grunts working at a commercial firm. The busy brokers pulling in 500k to over 1 million in commissions a year do not have time to do such things. So often these for sale flyers have critical errors or omissions in them that affect the cash flow or lendability of the property.

With my clients we have a confidentiality component in the LOI so we can get a look at the lease early before the purchase and sale stage. It's better to find out problems then before spending thousands with attorneys negotiating the PSA. Half the time the listing brokers or even the sellers in some cases do not even know what is in their leases!

I have had to screen copy before sections and show them that tenants were required to report sales and other items.

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Courtney most of my clients right now we are buying STNL absolute NNN for a few reasons. We can get on investment grade tenant with 30% down fixed loan for 10 years in the 3's for rate with 25 to 30 year amortizations. Cap rates have risen on STNL so in the 6's for cap rate and rates in the 3's you get almost a 275 basis point spread for return and can be passive.

Retail centers lots of lenders have left the market and have little appetite for those properties. When some would do 30 or 35% down now many want 40% down on retail centers and interest rate is high like 4.5 to 5%. They also want almost 12 months reserves CAM and rent averages to feel secure the owner can work through COVID going away and possibly returning again in the fall.

Lenders with STNL investment grade tenants with essential businesses the lenders are not imposing those reserves and still giving great rates with minimal down.

So the retail centers now for us to consider buying the cap rate has to be REALLY HIGH for dealing with that otherwise you lose one tenant and fill another one up and do a lot of treading water for not much extra additional yield. We can still get good financing when it's a Starbucks 2 to 3 top type property with 1 to 2 other solid type of tenants.

I stay away from mom and pop centers with 10 to 15 tenants to manage. Big headache. I know lots of owners in Texas about over 300 of them for retail properties.

Lease, Lease lease! There's not such thing as a standard NNN. Plenty of brokers try to pass of a "true" or 'absolute' triple Net. but otherwise its a variation of NNN. Review the lease to see what LL is responsible for in addition to their own asset management costs, legal (most, but some can be passed to Tenant), accounting (some can be passed).

There is no rule of thumb other than "it depends" I have a short video on my YouTube which talks about these in detail...