How safe is NNN investing?

Question

Hello,
I am new to the forum.
I am looking into investing some commercial properties.
I am specifically looking for a single tenant NNN investment.
I have found some restaurants such as Hardees, Tacobell and PizzaHut.  Also Dollar Generals..
My question is how great are they?
As a newbie is this a good starting investment?
A lot of them have 20 year lease which sounds awesome, but are they real?  Or can the breach the contract if they go bankrupcy or something?

Thanks in advance.

Jeff Fry · Answer

I'm sure there are better ones, but since we subscribe to salesgenie.com we use that.  We have it for mailing lists, but it also shows a business credit rating.  We don't go strictly by it, it's just another piece of the puzzle.

Frank Gallinelli · Answer

I've used Dun & Bradstreet (dnb.com).  There's a fee for the reports, of course, but it's better than making a mistake on a long-term lease.

N/A N/A · Answer

[LINK REMOVED - SPAM]

P.S. I also heard that you can get corporate credit checks from www.moodys.com and www.standardandpoors.com.

N/A N/A · Answer

Hello,
Thanks everyone for your answers.
Now how can you check the ratings of possible tenants?
Any website?
Thanks.

Frank Gallinelli · Answer

You got some outstanding advice from TN-Apprentice.  I'd like to add just one thing to the "know who your tenant is."

Make you you know who your lessee is, also.  Many national tenants may actually lease their property in the name of a real estate division, so the lessee on your deal with Big Box Retailer might actually show a different name.  Pull a D&B and follow the money.  Find out the proper name of the parent company and require that they guarantee the lease.

Jeff Fry · Answer

One of the great benifits of the NNN lease property is that you are not caught off guard by things like property tax increases, lots of snow removal, unexpected repairs, and things like that because most (if not all) expenses are passed along to the tenant.  It takes some of the risk away from investing.  They are more work as far as keeping track of expenses for CAM audits, but setup the lease so the tenant pays expenses direct and you're home free.

Mark R · Answer

Great reply TN-Apprentice

I myself didn't know anything about NNN but I got a ton of information from your post alone. I will be considering NNN at some point in the future.

Scott Miller · Answer

From a financing standpoint, there are programs that allow up to 90% financing for this type lease tenant arrangement.

Regards,

Scott Miller

N/A N/A · Answer

In general I think the leases are pretty good (of course, each lease is different and will need to be looked at by a commercial lawyer). If the company goes bankrupt, though, then you're out of luck, of course. But there are lots of examples of things like dark Walmarts, where Walmart closes a store (maybe because they opened a superstore nearby) but keeps paying on the original lease until it expires, sometimes years later.

A couple of things to think about:

1. What happens if/when the lease expires? Obviously you'd want to get a new tenant, but you'll need to think about what you can rent your property out for vs. what potential tenants can get at other locations (i.e., market rent). It's still real estate, and things like location and all the other stuff you already know still holds true.

2. While these properties are generally priced based upon rent (i.e., cap rate), beware that some may be set up with above market rent to inflate the purchase price. For example, let's say I own a restaurant and I own the building, but I need more cash for my business so I decide to sell the building and offer a NNN lease. Now, I'm just going to make up some numbers just to give you something to think about. Let's say that I'm an 8%-cap type of tenant, and that true market rent of the building is $3333/month or $40k/year. Given an 8% cap rate, that would make a sale price of $500,000. But, instead I decide to make the deal seem a little sweeter, so I set up a 5-year NNN lease where I'll pay $5K/month or $60k/year. Great, right? Well, what does that do to the numbers. Now an 8% cap rate would make the sale price $750k, or $250k over market value. You end up fine for those five years (assuming my restaurant doesn't go under) but if I leave when the lease is up you are now stuck with what is effectively a $500K property for which you paid $750K, and you'll be unlikely to get a tenant who is going to come in and pay above-market rent. So how are you ever going to be able to meet your loan payments, let alone cash flow?

3. Another risk is rising interest rates. These can bite you two ways: (1) most of the commercial loans for these properties, while amortized over 20 years or so, will be called due in 5 years, which effectively means you have to refinance then. Since your rent may be fixed for a much larger period of time, a sharp rise in interest rates can cut seriously into your cash flow (or even turn it negative, potentially); and (2) higher interest rates will drive cap rates up (since buyers will need to be able to cover the mortgage with a higher interest rate). If you need to sell, and interest rates/cap rates are up, that will drive down the sale price you will get (since you can't change the rent until lease expires). It's impossible to know what interest rates will do in the future, of course, and if they go down it can translate into a big profit for you.

4. Make sure you know who the tenant is. In the case of many franchises, it is not the corporation that is signing the lease, but the franchisee. Some franchisees are huge companies with 50+ franchises, a 30+ year history and excellent credit and thus are much less risky than say a person who just bought his one and only Taco Bell/Pizza Hut/Hardees/etc franchise. If that one franchise goes under, you are out of luck.

5. There's also the "risk" that your property might appreciate greatly. While you'd obviously like the property to go up in value, if it actually does shoot up there will be no way for you to take advantage of that fact until your long-term lease expires. I've seen people hoping their tenant actually does go bankrupt because they know that the property is now worth so much more than it was before that they would not only be able to re-rent it quickly, but that they'd be able to get a much better rent than they currently get. Ah to have such problems...

The most important thing is probably to have a very good commercial real estate broker who knows about triple-net properties working with you to help you evaluate all the details. I'm seriously looking at getting a triple-net right now, but I haven't yet done so. I have found a decent book that just deals with these types of properties and covers lots of specifics:

Armchair Real Estate Millionaire.