An Introduction To NNN Investing
Retail Categories
The Investment
Types of Sellers
The Buying Process
Market Analysis
Highest and Best Use Explained
Location and Site Analysis
Financial Feasibility
Industry Trends
Due Diligence
Financing
Low Risks of Default
Sample Lease Agreement
Sample Letter of Intent
Sample Commercial Inspection Report
Due Diligence
Evaluation of the investment will include review of the:
Tenant
Real estate
Lease
Commercial real estate due diligence is more specialized and more intensive than a residential home inspection.
There is a “buyer beware” element to buying commercial real estate and a prudent investor is going to want a certain level of due diligence before they sign a purchase agreement. There are commercial services that can perform this service and issue a report. Additionally, the bank is going to want some level of due diligence, especially, a Phase 1 Environment Report.
Here is where a little judgment enters the picture. What level of due diligence should you strive for. If you were purchasing an older property with a dated building and an expiring lease, an in-depth due diligence report would be wise.
If you are purchasing a new property with a national tenant from a preferred developer you could make some assumptions that the developer and the national tenant has already performed extensive due diligence with an in depth analysis of the demographics, traffic counts, highest and best use evaluation and local economic factors.
Some buyers feel no need to visit a site in the previous example and trust the national tenant’s findings and their commitment to sign a long-term lease.
Site Visit or Not
The prudent investor should assume that the property would be vacant at some point by tenant default or an expiration of the lease. Do you really want to be surprised that the access is poor, the building is in disrepair, adjacent properties are not traffic generators, the road system is poorly maintained and surrounding neighborhoods are in economic decline.
My personal opinion is to take the long view and go the extra mile to see and touch what you are buying or have someone competent perform this function. Great locations can generate income for generations.
Tenant Evaluation
Tenants can range from a local business serving the local community to a publicly owned international company with hundred of locations. Evaluating the tenant is critical to your investment because their ability to meet the terms of the lease is essential to your return on the investment.
National tenants tend to be easier to evaluate due to the availability of public information. The national rating agencies such as Standard and Poor’s and Moody’s provide much of the information to assess these national tenants and provide credit ratings that can be used to measure risk. Cap rates will usually be adjusted to reflect the quality of these ratings.
Local tenants require more due diligence where tax returns, company sales history and financial statements must be relied on for evaluation. Industry standard financial ratios should be in line and positive growth trends should be apparent. If you were considering a real estate investment with a tenant that cannot be evaluated by the credit rating services, it would be wise to employ resources to assist you in evaluating the tenant’s records.
The Tenant evaluation should include:
1. A review of the tenant’s credit rating
2. A review of the tenant’s financial statement
3. How long has the tenant been in business
4. Review of the principals
5. Review overall financial health
The real estate evaluation should include:
1. Macro and micro demographics
2. Site analysis
3. Traffic counts
4. Population and income growth
5. Building condition
6. Easements and encroachments
7. Environmental concerns
The scope of work for a developer is beyond the scope of this book but a summary of some of their considerations is included in the appendix for the interested reader.
As an investor, it is fair to assume, that much of the real estate decisions by a national tenant has been accomplished to ensure a successful location. The success and profitability of a national company is dependent on their ability to evaluate a market and a particular location within that market.
As an investor, if you are investing in a location with a proven national tenant, such as McDonalds, KFC, or Family Dollar, you can be assured their decisions were supported by an in depth analysis by their own real estate department.
The quality of the national tenant is in some respects an insurance policy for your investment decision. Due to the forgoing, the level of due diligence for an investor considering a location with a national tenant could be less than that for a developer starting from scratch.
The Lease
The lease terms will vary between national tenants but should be written in clear understandable language. Ambiguity in terms should be a red flag. The value of an experienced attorney is important at this stage.
The more obligations of the landlord, the less market value of the lease. A good understanding of any tenant termination clauses is important. Are default remedies enforceable? Can the tenant vacant but still pay rent (going dark)? Can the tenant sub-lease the property? These are but a few of the terms that can negatively affect the value of the lease.