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
Low Risk of Defaults
The following default rates, over a fifteen-year period, were reported by Standard and Poor’s Corp/ Business week in 2002. This provides some insight into the relative risk of a default for a particular credit tenant.
This also explains why the market tends to price properties with lower credit ratings with higher cap rates. A higher cap rate means the investment will have a higher rate of return.
Note: The “cap rate” is the (interest rate) the investment returns in the form of it’s “net operating income.”
$1,000,000 investment
$100,000 annual net operating income
10% cap rate
Historical Default Rates Based on Credit Ratings
Original Rating/ Default Rate %*
AAA .52%
AA 1.31%
A 2.32%
BBB 6.64%
BB 19.52%
B 35.76%
CCC 54.38%
The credit rating gives you the level of risk of default but location analysis and a company’s business model should also be evaluated.
With the aging population in the United States, drug stores are currently considered a growth industry while video stores represent a declining market segment. The Internet has allowed new technologies to provide an alternative to renting videos from a store. Understanding the macroeconomics of an industry and market segment can help guide your investment decisions with respect to adjustments for reported credit ratings.
Value is in the Real Estate
If a default occurs, it’s the real value of the real estate that you have to fall back on. A poor location may be difficult to re-lease. If long-term demographic trends are unfavorable for the area, a long-term vacancy could be a negative. The type of building the tenant was using could be hard to retrofit. All these consideration are relevant to the initial investment decision. Looking forward and assuming the worse case scenario should be part of the investment decision.
As you can see the default rates are very low for the top rated companies and one of the reasons that NNN leases are considered low risk investments. Many NNN retail leases are for 10-15 years with multiple option periods. 3 – 6 (5 year) extensions are common. The question for the investor is the likely hood that the extension will not be exercised.
If not, will re-leasing the property be possible? Will the current market lease rate be below or above the lease extension rate you were anticipating and will the current market rate cover your debt expense and still return an acceptable rate of return?
Even when a company has an excellent credit rating, its business model should be evaluated to ensure the long-term security of the investment. Finally, location will be the final factor of future value. The initial rent may be attractive but if and when the lease ends, reality will set in. It is unlikely that a mid block location will be as desirable as intersection with a stoplight.
“Always Think Location”