Has anyone done triple net leases? good or bad stories to share?

29 Replies

Joel Owens has been very helpful, if not for him we wouldn't have known about triple net leases.

My brother is considering putting some money in triplet net leases.

Has anyone done triplet net before? Any stories (good or bad) to share?

What do most people do when the lease expires or when the tenant moves out? Do you try to sell the property at a discount or find another commercial tenant?

Many thanks in advance.
MJ

Hi Mary,

Hopefully some others will chime in on NNN perspective.

To give some perspective understand that the posters brother likes passive income and security over increased returns. So where some might see more gain or a higher cap with other investments a conservative investor will usually see excess risk for the extra return.

Mary the primary term of the lease spells out option periods and renewals and how much advance notice has to be given that the current tenant plans to not exercise the renewal option. So you get notice way in advance of a tenant not exercising the option and then can start planning whether you want to sell or re-tenant the property.

If the location for NNN is quality and the structure is not a unique shape (such as a sonic drive thro fast food place etc) then many tenants will be vying to rent out that location. If you own one of the better locations the existing tenants would not want to move usually anyways.

Hope it helps.

Triple net lease investing or NNN investments are great investments as long as you are comfortable with the credit quality of the tenant, believe the location and building will be demanded by other tenants in the event your tenant were to default or not renew their lease, and that you are not paying for an above market rent, which could inflate the value of the property to a point where you couldn't recover your initial investment if something were to go awry.

Mary Joe,

You hit the nail on the head as to one of the main risks of what happens when a NNN tenant leaves a single tenant property. From personal experience, I can tell you that what happens next isn't always pretty - which I will get to in a moment.

If you are considering a single tenant NNN leased investment you have to evaluate thoroughly the market, the location, the building, the lease, and the credit strength of the tenant - all are important and should line up.

In 2009, I represented a property investor that owned a 35,000 SF free-standing Circuit City, and when CC closed their doors, my partner and I were tasked with securing a replacement tenant. This was a prime location at the entrance to a major mall in the market - however, the market conditions in 2009, the size of the building, and the fact that this was an older prototype building all worked against us. Regarding the prototype, the building itself was older and long and narrow, so for retailers in the same SF range, the building just didn't fit into their prototype design - especially in a down market where there wasn't much expansion happening and retailers could pick and choose the best vacant CC buildings. Today the building has been carved up to two smaller retailers on the front and a large Chinese buffet in the middle section. The back portion of the building is still vacant. This is an extreme example, as most investors starting in single tenant NNN leased investments probably won't be buying 30,000+ SF single tenant buildings, however, it does highlight the importance of always thinking about what if the tenant leaves? Will my building be in demand? Will I be able to replace the tenant with a similar credit tenant?

Here are two articles which sum up better and in more detail anything I could write on the subject:

The Risks and Benefits of Triple Net (NNN) Properties
http://www.creonline.com/risks-and-benefits-of-triple-net-properties.html

Triple Net Leases: Pro's and Con's
http://www.berkeleyinvestment.com/Newsletters/Newsletter%20March03.pdf

Also, here are some brokerage companies that specialize in the sale of NNN lease investments to give you an idea of what's out there:
http://calkain.com/
http://www.stanjohnsonco.com/
http://www.colliersnnn.com/

Lastly, Net Lease Advisor (which is associated with Calkain) is a great resource for credit information on the retail net lease market. Here is the website: http://netleaseadvisor.com/

Good luck!

Damon

p.s. - Sorry, I couldn't figure out how to make the "link" button work for the websites, so you will need to copy and paste.

Yes Circuit City took a bath years ago. 2009 was a bad time in the cycle for many markets. Trying to sell at that time put you at a disadvantage as a seller.

I saw many of the Circuit Cities converted into workout gyms and things like that. The second and third generational leasing of such a large building leads typically to lower rates than what a corporate tenant is paying out.

Usually that size of a building isn't bought by individual investors but by the big corporate buyers. Individual investors play usually in the smaller triple net space unless they are pooling funds and buying as a partnership.

Big box retail is not something I would tell my clients to buy for triple net. You see Best Buys right now selling at high caps but they are looking at a major default soon as most buyers are looking in the stores and buying cheaper online. The high cap you are getting as soon as Best Buy defaults that return will be gone and you will be left with a large building.

The benefit to what many individual investors buy for triple net is that the size of the building (usually under 10,000 sq ft) can be re-rented if the location is good to a ton of different types of businesses for good rent rates. The larger buildings are like houses in that only a handful have the ability to occupy the whole space like a Circuit City. A large building like that concentrates too much risk in one property where for the same money down you can split out into different asset types in the local market for triple net or own buildings in various markets to diversify.

The links listed are a few NNN companies. I have over 60 when I look for clients. You will find many big NNN companies simply push their inventory and a bunch will not take a ton of time working with buyers to find the right match for them. The brokers often work on teams sometimes and the goal is too push the listings.

I am more of an individual company NNN broker that works with buyers to locate what they are wanting and spending the time to find it. Nothing wrong with either approach but the bigger companies tend to be about volume.

Thanks everyone for the feedback.

I do believe that NNN is no hassle (for as long as you have the tenant in place) but it is by no means LOW risk compared to residential properties.

The biggest risk comes with finding a commercial tenant when the lease is over or when the tenant defaults, with residential properties you are almost always guaranteed a tenant whereas with commercial it can really take years before a commercial space is filled.

Even if one purchases a NNN outright with cash, I would assume the maintenance and property tax will be a very substantial burden on the owner while the space is vacant.

MJ

You should also take care as it relates to periodic inspections. Most NNN leases I've dealt with require the tenant to maintain the property to certain levels over the term. I've served as an expert witness regarding poor performance relating to tenant maintenance of roofing, mechanical systems and tenant modifications without proper permitting. Although the tenant paid rent for ten years, they failed to maintain the property and the owner had to sue for costs due to their neglect in excess of $75,000.

Don't forget you can also lose your entire investment. We live in an era in which many business schools teach that integrity and ethics are obsolete.

As another website points out, a triple net lease is basically an investment in the tenant's business and if he or she fails, you are stuck with an empty building and a loan payment that continues. It can take months or years to re-lease a property and if you run out of money to pay your bank, you're out of luck.

Some people will advise you to check the creditworthiness of the tenant, but don't bother. As we learned in the financial crisis, the ratings services give their stamp of approval to any client willing to pay their fees.

The ideal situation would be to get personal guarantees from the tenants or put liens on their houses, boats, and other assets. How do I know all this? My family owns a building that we leased to a KFC franchisee who has since gone bankrupt.

My clients have had nothing but great experiences with triple net leased investments. Now, I'm referring directly to NNN deals, whereby the tenant is responsible for everything. NN deals tend to yield more, but the roof and structure responsibility for an out of state landlord can be a pain.

Regarding your brother, my recommendation is to work with a very experienced broker who understands the NNN asset class thoroughly. Make sure the location is on a highly trafficked retail corridor, with a low rent to sales ratio, in a major metro area, with a solid franchisee or corporate tenant.

Originally posted by @Richard Swearinger :

Don't forget you can also lose your entire investment. We live in an era in which many business schools teach that integrity and ethics are obsolete.

As another website points out, a triple net lease is basically an investment in the tenant's business and if he or she fails, you are stuck with an empty building and a loan payment that continues. It can take months or years to re-lease a property and if you run out of money to pay your bank, you're out of luck.

Some people will advise you to check the creditworthiness of the tenant, but don't bother. As we learned in the financial crisis, the ratings services give their stamp of approval to any client willing to pay their fees.

The ideal situation would be to get personal guarantees from the tenants or put liens on their houses, boats, and other assets. How do I know all this? My family owns a building that we leased to a KFC franchisee who has since gone bankrupt.

Was it a nonrecourse loan? Was your familes' personal assets held against or that of the LLC?

I just bought a small strip center in a very strong location.  It was 57% occupied at the close of escrow.  A good chunk of the vacant space was just leased to an optometrist. 7/11 is one of the tenants in the building. 

I am basically a multi-family investor but could not find any decent apartments to purchase. Everything seems so overpriced these days. 

I may sell off more apartments and move the money to retail.

What @Paul Falbo  said is a great point to consider. Just because a tenant signs a lease agreeing they will maintain the building does not mean they will maintain it to your standards or even at all!

I've seen various NNN or modified Net leases where the tenant does not complete simple preventative maintenance on items like HVAC units (which end up with major repairs or need replacement) or parking lot repairs (asphalt and concrete are very expensive to replace).

While considering NNN leasing be sure that you or your representative visit the property periodically and following up with the tenant to be sure repairs/maintenance are actually happening. Requesting photo evidence or names of vendors used also helps when verifying repairs are made to the correct quality.

@Steve Olafson Thanks for sharing your thoughts. I am a NOVICE investor currently trying to get into multi-family, as I have invested as much as I feel comfortable in SFR. The reason I've been scared away from retail is because of all of the store closings I've heard about in the last 12 months and this notion that Amazon and others will continue to take market share from brick and mortar retail locations. Also, retail stocks overall have had a very difficult year which makes me question if they are willing to invest more money into more locations. I too think that apartments are overpriced but feel multi-family may be a safer, more conservative investment. Love to hear yours and others thoughts.

@Brian H.  

 Driving your decisions with data is important.  But, you can use data to talk yourself into or out of any investment. 

7/11's are not going to be replaced by online soda machines.  Nail salons won't be either.

Stick to good properties with barriers to entry and you will likely have multiple exit strategies.  Supply and demand will drive the market.  So maybe less retail is developed than in the past.  The odds of an inexpensive location being overbuilt is greater with both apartments and retail.

Hi Brian,

I am bullish on retail.

I think the issue is comments about retail are being painted with a broad brush.

Big box and small box retail has issues. These are stores where people can look and touch and then go online and shop cheaper.

I believe while Amazon will take away some market share as people go online that retail brick and mortar will not go away. The reason is some shoppers get a high from going into a store for the experience etc. Also some will not order online because some items like clothes they like the thought of trying them on in a store and buying versus ordering online  and having to go through the hassle of returning when they do not fit etc. 

So what these big box retailers are doing is starting to build more micro stores that are smaller and stock best sellers to drive more sales per sq ft. This way Amazon and other online stores will not impact them as much. Brick and mortar retail is changing but not going away.

I focus on retail day in and day out. People on the outside looking in do not understand this asset class the same. When my clients buy strip centers we are focused on destination type tenants. Doctor's, gyms, hair cuts, restaurants, dry cleaners, karate schools etc. You have to ask yourself if the tenant is a place where tenants have to go and spend money and they can't do it online.

I am fine with a hobby shop tenant if the owner is rich and can easily afford the rent. If it's a startup with little cash it's a no go.

Forgot to mention if it's a small national tenant in strip guaranteeing the lease then you are protected more with TI.

If it's a franchised tenant or a start up you are giving a chance on you need to look at free rent in place of the TI. You could do the TI and then tenant fails in the first year and you are out all of that money. You have to look at also the finish to the unit the tenant is wanting to do themselves how expensive it will be to release if they go dark and what you will have to do to the space as a landlord. Example if a tenant does minor TI for their concept and it goes dark then as a landlord it would be easier to re-rent. If the tenants concept is oddball or has specific heavy TI components then if they go dark it could be very expensive for the landlord to get in re-rentable shape again as most new tenants would not want the space in it's current special use form.

Also if it's a weak tenant that is not national I do not like to see rent increases every 3 or 5 five years at 2% a year. I would much rather see that tenants rent increase 2% yearly and collect it that way if they go out in year 3 I have made more money. National tenants if credit is backing it with thousands of locations then getting the rent bumps of say 6% every three years isn't as bad because the chance of going dark for that space is less.

When you get to non-franchise and franchise tenants I want to see sales per store ratio to the rent they are paying.

If you do this day in and day out there are ways to mitigate risk and put success in your favor. 

   

I have to reply this one to bookmark it.

It's very important to have an experienced attorney represent you in negotiating this type of lease. I occasionally negotiate an NNN where landlord has an in house leasing agent handling negotiations, and my client (tenant) typically comes away with a much more favorable lease in that situation.

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Who on this site has current NNN experience? Rima and I are considering investing in some NNN properties, as we are selling 14 appreciated SFRs (owned outright). It seems that the power difference between a big national company with a platoon of lawyers and an investor who has one or a few NNN properties is a major factor to consider. If they do not properly maintain the building, it may be necessary to sue them. It would be wonderful to speak with NNN owners and compare notes on how well various tenants comply with lease obligations.

I helped write the ASTM E2018 standard for property Condition Assessments which first came out in 1999, and my company also provides a full range of environmental consulting services (Phase I, asbestos, mold, lead PCBs and so forth).

Hi Stephen, your concern is valid. I am a engineer/contractor and have seen what happens at the end of a lease. I have seen 2 million dollar refrigeration systems destroyed in less then 15 years due to no maintenance. I am sure you are not looking into investing into a food plant but we install very large refrigeration systems that need maintenance. I have had many landlords call me after a tenant moves and I have to tell them it would be cheaper to buy a new system instead of repair. Easiest way to stay out of trouble is to assume a total loss in say 15 years when the lease ends and include the system loss in the 15 year lease payments. 90% of these tenants look at the building as a way to make profits and do not want to place their profits back into the building especially during the last 2 years of the lease if they are planning an exit strategy. At the end, the tenant goes from very little maintenance to nothing at all.

@Stephen Masek My brother @Alexander Budka and I have combined 13 years of experience owning, managing, leasing and brokering NNN deals. Honestly, it may sound overly simple, but the number one aspect to consider when buying NNN deals is the classic RE investment aphorism: location, location, location. Other things to consider are the strength of the actual entity the lease is signed with (and make sure to thoroughly understand leases!). Evaluating rent-to-sales ratios can give insight into the performance of the business. Definitely analyze comparable sales and lease comps in the area.

NNN acquisition criteria really varies depending on your risk appetite. You're probably looking at NNN nationwide I presume? A slightly higher cap rate of 6%-7% out of state vs. a 4.5-5% cap rate in CA isn't that great of a difference in the long term. NNN deals located in in-fill, highly populated, growing areas have a much brighter future in terms of re-leasing potential if/when a tenant decides to vacate, versus some random property in Nowheresville, Midwest that has very limited future re-leasing potential.

Now is actually a great time to buy NNN deals. Because the uncertain interest rate environment, NNN sellers are more likely to be flexible on pricing as the asset class is closely correlated with interest rates, which are on the rise, meaning its becoming more of a buyers market out there.

It's not really a buyers market out there. Regardless of interest rates rising anything sub 3 million in price is not moving much off of cap rates for STNL.

How do I know? I look at about 1,000 properties a week for clients nationally.

Lot's of all cash offer sub 3 million. When their SFR's and or apartments are getting 3% return in CA with tons of trapped equity then it's a win for them to 1031 exchange into passive commercial NNN and get a 5 cap with rental increases. They take full advantage of trapped equity and buy all cash.

Cap rates are moving up slightly by maybe 10 basis points but so is debt so nothing much to gain there.

If you can buy something 5,6,8 million with debt and some down then the cap rate starts moving the needle some. In the 4 to about 14 million range typically too little for the big funds to go after and too big for the smaller buyers. In the range cap rate likely better and loan you can get better.

Cap rates tend to move up in the 3 to 4 million range in the 6's with retail centers such as 3 to 4 tops like Aspen Dental,T-mobile, Starbucks.

It can be true that at the end of a primary lease term with STNL that the tenant patches things knowing they might leave. Of course they are not going to give you all new stuff if they are vacating the space that just does not make common sense.

There is a cost reserve stable to allocate for new roof,etc. as on owner. Even if they want to renew the option period they might want to renegotiate to get certain items replaced as part of a new TI package to stay. That is also an opportunity for the owner to restructure the lease also so it's a dance where both parties are trying to get something of value.

Someone could try to negotiate a clause that says tenant will replace certain items once they hit their life average expectancy or sooner instead of repair but likely they will balk at it. 

The cold belt states tend to have higher ongoing cash flow but less value potential in the future for the land and rent growth.

CA is more of an appreciation type state like New York. There are great areas outside of CA in warm belt states such as GA,TX,etc.

In GA about 5 million more plus people in the next 10 to 12 years are expected to come here. We are growing like crazy. TX has growth also but also less favorable and more unstable weather in certain parts of the state. I have clients in many states buying NNN single tenant and multi tenant.

You need to talk to people on the phone to see what is really available out there while doing a 1031 exchange and have a plan of action.   

Having a big national / international company as a tenant also means that they have far more lawyers than we "little fish" investors.  If they fail to maintain the building, the only option is to sue them.  

I recently hard about Delaware Statutory Trusts (DSTs). They work for 1031 exchanges, and provide a way to have fractional ownership of one property, or a portfolio of properties. Some are for NNN properties. For smaller investors taking care to not have too many eggs in one basket, investing in several different DSTs may be much better than investing in one NNN.

 

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