An Introduction To NNN Investing
Retail Categories
Investment Types
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
Introduction To Triple Net Real Estate Investing
Specifically, the “triple net lease” (NNN) is where the tenant assumes responsibility for all expenses, such as property taxes, maintenance and property insurance.
As a real estate investor you will be looking for a return on your investment, in the form of appreciation or appreciation and income. Your options are to make a direct investment or in a public investment, such as a REIT (real estate investment trust).
In a NNN direct investment you produce cash flow, reduce risks, benefit from leverage, and eliminate the headaches that comes from maintaining and managing property. I can not tell you how many clients have said, “Kent, I am not interested in taking over someone else’s problems or “ tenants are always causing problems.”
There are many stories that refer to the headaches that come from real estate ownership but the broken water pipe or stopped up plumbing and the 2:00 am phone call from the tenant seem to sum up a central problem for owners.
Occasionally the tenant becomes insolvent and cannot pay the rent. Occasionally the lease expires and the property sits idle for long periods. To often the property becomes functionally obsolete and must be demolished.
These are headaches that come with real estate ownership. But none of these situations diminish the fact that real estate is tangible asset with permanency that shelters income from taxation and can be a hedge against inflation.
Net Lease
Another question I often hear is “what does net lease mean.” The “net lease” is designed to minimize the need for property management and transfer those responsibilities to the tenant. Once the agreement is in place you start to receive monthly rent checks without the accompanying management worries or the risk of losing your tenant in the short term.
Most national retail companies find it more feasible to lease their real estate as an operational expense rather than invest their capital in real estate ownership.
Companies say “ we make a greater return investing our capital in our core business rather than in real estate ownership.” This has opened up an opportunity for real estate investors to secure a low risk (similar to bonds) investment with the added advantage of sheltering income.
There are several net real estate investment property types, such as office buildings or industrial/manufacturing but we will not cover those in detail in this book. Below is a brief description of non-retail property types.
Office
Office buildings are usually classified as Class A, Class B, Class C and Class D.
Class A office buildings usually attract long-term investments; have modern state of the art technologies and amenities. They are the highest quality, usually large buildings located in the most desirable locations.
Class B office buildings are usually in very good condition but lack the newest technologies. They are usually 5-10 years old and may need minor maintenance but are still located in desirable areas with good to excellent access.
Class C office buildings are 10-20 years in age but still have stable lease rates. They are generally smaller with a variety of small business tenants. The local area may or may not be showing signs of deterioration but vacancies of adjacent properties may be evident.
Class D office buildings are generally located in areas of deteriorating physical and demographic characteristics. Vacancy rates within the area are moderate to high with declining lease rates. These buildings are usually in need of substantial maintenance or rehab.
Industrial/Manufacturing
Industrial/manufacturing buildings will be located in designated light or heavy industrial areas. The cleaner businesses such as electronics, medical, and distribution might be found in “business parks” while the steel and petroleum type businesses would be concentrated in traditional industrial parks.
Industrial buildings often contain many special features such as loading docks, cranes, higher ceilings and rail spurs. Building sizes may range from 50,000 – 1 million square feet. These special features often make it difficult to locate new tenants when vacated.
Note: The above property types can be excellent investments but have special tenant needs which are outside the scope of this book.
We like the retail sector because the initial investment is likely to be within reach of individual investors. The retail sector also offers more available properties and a wider selection of tenants. Retail locations are more widespread throughout the country.
Retail Properties
Retail properties include restaurants, banks, auto parts, drug stores, big box stores and a variety of other businesses that offer a products or service directly to the public.
This category offers many investment opportunities with a broad number of national tenants. Square footage ranges from 2,000-20,000 with new construction investment price ranges from $1-10 million. The majority of these investments are $1-5 million.
As an investor, purchasing retail real estate will create a landlord tenant relationship. As the landlord you will enter into a lease agreement with the tenant and spell out the responsibilities of each party for the term of the agreement. These agreements will be one, or a version of several types of leases listed below but keep in mind that all agreements can be modified to suit the parties.
Lease Types
Gross Lease
This is an agreement where the landlord (owner) pays most expenses related to ownership of the property such as property taxes, insurance and maintenance. The rent to the tenant will be higher than a net lease in order to cover these expenses.
Net Lease
There are three versions of the net lease, which requires the tenant to share a portion of the property expenses such as taxes, insurance and maintenance. The single net (N). The double net (NN). The triple net (NNN).
The Single Net might require the tenant to pay insurance.
The Double Net usually has the tenant pay property tax and insurance
The Triple Net requires the tenant to pay the taxes, insurance and maintenance.
Note: There is one more net lease referred to as a Bond Lease where the tenant would agree to a Triple Net lease plus any and all other expenses including replacing the building if destroyed.
Net Leased Advantages
The retail sector favors the NN and NNN leases due to the investment return by using their capital to invest in their core business. Rent is an operational expense just like utilities.
From an investor perspective, owning property with a NNN tenant has several advantages not available with other investment types. Below are a few of the most common advantages.
1. Limited Property Management Responsibilities
One of the most important aspects of net leases is that the tenant assumes responsibility for most landlord responsibilities. The leases are usually 10-15 years and the tenant will perform upkeep on the property, pay taxes and insurance.
2. Low Risk Investment
When leasing to large national retailers, the parent corporation usually guarantees the lease. The default rate is usually a function of the company’s credit rating. Strong credit ratings reduce the risk. The long lease terms reduces the re-leasing risks.
3. Estate Planning
Proper estate planning can ensure that the income stream and appreciation continues after death. There is little need for ongoing management expertise by the heirs.
4. Tax Benefits
Depreciation and the IRS 1031 exchange provision allows for the income to be sheltered. On sale, 100% of the capital gains tax can be avoided by reinvesting in like kind properties.
5. Capital Preservation
Real estate has permanency. It should continue to appreciate and is usually not subject to many of the fluctuations common to the financial markets. The long-term leases add stability to its value.