Newbie: NNN property valuation??

Question

Hi folks!

I'm just starting out in the world of CRE. This is an awesome forum, and I've been trying to absorb as much as I can. Hopefully one day I can graduate from being an absorber to a contributor :)

I'm looking at a highly rated corporate NNN leases, and I'm getting stuck on trying to figure out how to value these properties in preparation to make an offer.

Are there general tips/methods for valuing properties to arrive at a purchase price? I'm leaning toward some sort of cash flow valuation, but it seems that most people use some sort of relative/comp valuation.

I ran some numbers for a property priced at $1 MM with a cap rate of 5.1% and new 10 year lease (no lease increase for duration). The bank says I need a LTV <= 75% and a DSCR of >= 125%. Assuming a 4.75% interest rate (25-year amortization), I get a DSCR of 115%. Does it make sense to put more money down (say to 30%) to get the DSCR to 125%? To me, it seems that it would equate to paying a premium for the property, but my broker says that this is the premium that I need to pay for a corporate NNN. Is this a valid argument?

I'm also trying to wrap my mind around what the 'terminal' value would be (i.e., what I could realistically sell this for down the line). I understand that as the lease term gets shorter, the cap rate should increase since there's probably more 'risk' that the tenant leaves -- meaning that the price will decrease. Is this the way to think about it? And if it is then how can I get a more quantitative idea of what the impact would be? I don't need a specific number but just a ballpark idea. Is this something that I can try to incorporate into my valuation of the property? And if so, how?

I appreciate any responses in advance!

Robin

Account Closed · Answer

BTW- one of the very BEST articles on NNN leases online: http://www.creonline.com/risks-and-benefits-of-triple-net-properties.html

Very easy to read and a great article featuring pros/cons of net lease deals.

Account Closed · Answer

This is all dependent on your risk tolerance and experience. 
IMO, one of the biggest challenges with NNN leases is figuring out the terminal value, or the price a property will fetch if it eventually gets sold.

The honest truth is if you're buying it at 5.1% CAP, as you get closer to the end of the initial term, you see that CAP rate rising significantly, to maybe 8-10% CAP. That means that a $1m purchase just lost over 60% of value. So if you bought it at $1m, it might sell for only $500k after 4-6 years (assuming a 10-year lease).

With lease than five years left on the lease, the market of buyers is VERY limited. I'm encountering this with a LOT of sellers who are desperate to unload on their NNN leases. I don't think it's the right thought to say, "I'll buy it at $1m, maybe it'll sell for more in the future". It all depends on location, but I'll tell you what, a LOT of these net properties are in weaker locations. You have to conduct your own analysis on this.

Also, your broker's sole purpose is for them to make a deal for themselves. They just want you to buy anything to make their commission. Nothing wrong with this, but when it's your own money going into a deal, you had better make sure you have all of your own bases covered.