The two NNN tenant guarantees to avoid are small franchises, and mom and pop operators. These smaller, private tenants are best left to experienced NNN investors who are able to evaluate their risk and worth despite the fact that they are not high-grade net lease tenants.
While franchises are slightly riskier, as long as the franchise has a good credit rating (minimum BBB) and has between 50 to 100 stores, then they can be considered stable enough to avoid serious risk and provide reasonable income.
Savvy NNN and 1031 investors will only accept tenants that are at least subsidiaries of a parent corporation, which means there are a few hundred entities backing the lease, or a large franchisor that has been in business for at least 20 years.
Make sure that the entity that guarantees the lease matches the entity whose credit rating is being vetted. You can find the name of tenant parent corporations using a service like Google Finance or Motley Fool or Market Watch etc. Investment-grade credit tenants are rated by financial agencies like S&P, Moody’s and AM Best, and the higher the rating, the better the value of the property. E.g. a lease guaranteed by Walmart Inc. is a corporate guarantee – since the entity is listed on the stock exchanges. A lease guaranteed by Walmart Northwest LLC, however, is not a corporate guarantee since it is backed by a subsidiary of Walmart, not the actual parent.
Tenant Guarantees
Conceptually, a corporate entity agrees to be held responsible for all lease obligations in the event the tenant defaults. NNN leases are often sold as a safe investment solely because the lease and ensuing income, is backed or “guaranteed” by a credit-worthy corporation. In short – this clause ensures a guarantee of income. An NNN investor will receive rent checks for the entire term of the lease unless some circumstances ensue which terminate the NNN lease relationship. This is why the guarantee clause in a net lease is the most important clause of a NNN lease.
Some things to remember whilst doing a “guarantee” due diligence on tenant guarantees:
- No assignment without landlord’s consent or early guarantee opt-out
- Evaluate the corporation’s credit rating by looking up its default rate for stores. Lower default ratings means a safer net lease investment (and lower cap rate).
- Ensure the inclusion of a parental corporate guarantee of the lease – in the lease or via a lease amendment/addendum.
It must be reiterated that a corporate guarantee is best. Next best is a guarantee from a single-member LLC, and worst, a personal guarantee. However, all these guarantee mechanisms are often offered by NNN lease tenants. Now a safer triple net lease investment property should be backed by a corporate guarantee from the parent (not a subsidiary) corporation.
So that a NNN lease tenant’s parent company’s guarantee will hold up in a court of law, investors should try and include the following language in the lease:
- Negotiate with the parent company to sign an authorized guarantee agreement;
- the tenant’s parent company should use the phrase “primary (not secondary) obligation” when describing the guarantee; and
- further, the parent should specify and state in the lease that they obligate themselves (and the tenant) to pay the rent and carry out any (tenant) obligations stated in the lease.
In order to get the best advice on evaluating current or future tenants for your NNN property investments, save your headaches by calling the best brokers in this business at The Triple Net Investment Group.
