In exchange for completely passive income with no expenses to bear, a NNN property investment offers investors a slightly lower cap rate between 4-7%, yet offers long-term predictability and increasing cash flow, for decades. So how does a net lease investor analyze a NNN lease investment property as part of good due diligence?
Returns & Risk: Cap rates, or net income divided by the price, help as net lease properties are conventionally traded on the basis of cap rates. But other calculations also help. E.g. IRRs, Debt yields, and cash on cash returns. This last calculation will measure cash flows to the investor, typically free cash flow less debt service divided by the total cash outlay in the transaction. Investors should carefully analyze a NNN lease investment property’s risk, together with returns. Most importantly, triple net asset returns and risk are a function of the factors mentioned below.
Property type: Rates of return will vary by the type of triple net lease property and industry sector, be it a single tenant, restaurant, dollar store, pharmacy, grocery bank or other. The rates of return get lower and more stable, as tenants, with longer lease terms, stronger financials and solid corporate guarantees, appear higher on ratings scales such as Moody’s, etc.
Geography: NNN investment properties trade at different cap rates etc., depending on location – state or region or local market, also. West, East, and South East lead the way with lower cap rates (higher prices!), generally speaking. Triple net lease property investors also need to consider the absence of state-level taxation when looking at returns.
Financing: Mostly, serious investors have established lender relationships and thus know their cost of capital fairly well and hence their return expectations, even before engaging in property due diligence. This said, the IRR assumes greater definition during the study period and, the market value keeps varying until exit.
Taxation: 1031 or 1033 exchanges permit huge benefits to investors for estate and trust planning, including inter-generational transfer of assets. NNN investor cost bases and demand for accelerated depreciation also figure into their calculations. Opportunity zone plays get considered for additional tax breaks. Section 199A, also referred to as the 20% Pass Through Deduction, sometimes allows NNN investors to take a deduction for up to 20% of their qualified income from certain rental businesses. Notably, property holding vehicles – whether LLC, S Corp, C Corp, JV, SPAC, Trust, etc., will also cause after-tax returns to fluctuate.
Lease terms: Investors must be aware of net lease nuances that may seem innocuous but require foresight to avoid future implosions. Lease term length, assumption, co-tenancy, notice, renewals, rent escalations, termination, assignment, destruction, guarantees and estoppel clauses are among the most important clauses to analyze and negotiate well.
Tenant Credit: If public, a tenant’s credit rating is fairly easy to determine from sites such as http://www.zacks.com/, and https://www.nnnig.com/credit-ratings.html. Private tenants typically require the use of paid investigative services.
The real estate: The property’s traffic, income, spending, visibility and other demographics and descriptors in the local area, current and projected uses, state of maintenance and repair, of the physical aspects of the property all remain key to the net lease investor’s success. Although, the negotiations and analysis occur on paper, the value of the property is significantly derived from the physical aspects and location of the property. The NNN property’s value to the investor will also alter depending on the strategy and role used in the transaction e.g. buyer, seller, sale leaseback, build-to-suit, developer, etc.
At the Triple Net Investment Group, our expert brokers vet and monitor the nitty gritty of the constantly changing and multi-faceted, NNN investment property market, like hawks. Call us today for the best advice for analyzing your triple net lease transaction.
