What are net lease real estate investments?
Single Tenant Net Lease investing (NNN) involves acquiring free standing buildings that are leased to credit tenants. These properties typically have initial lease terms ranging from 10 to 30 years.
It is important to recognize subtle differences in the lease structure for single tenant corporately guaranteed leases.
There are primarily five main lease structures:
Bond Lease: Also referred to ‘Absolute Triple Net Lease’ The tenant is absolutely responsible for maintenance, operating expenses, repairs, and replacements for the integrated building and site area. A very limited number of credit retailers will sign this type of lease. This lease structure is in high demand and attracts significant interest from REITs and other institutional investors.
NNN Lease: This lease is similar to the bond lease structure. A NNN lease agreement designates the lessee (the tenant) as being solely responsible for all of the costs relating to the operation of the building which typically includes real estate taxes on the leased asset, building insurance and common area maintenance.
NN Lease: This lease follows the NNN lease concept, except the landlord is responsible for structural components, such as the roof, bearing walls, and foundation.
Modified Net (or Modified Gross) Lease: The tenant is responsible for utility costs, interior maintenance and repairs and insurance. The landlord pays everything else, including real estate property taxes.
Gross Lease: The tenant is responsible for rent which is set at a fixed amount often tied to indexes such as CPI or the like. The landlord pays everything else including real estate property taxes, insurance, repairs and interior maintenance.
Net lease investments offer the financial and investment benefits of real estate ownership with minimal effort and time in property management.
Analyzing Triple Net Lease Investments
The Analysis Framework involves a three step process:
Step I: Evaluate the Real Estate
The purpose of this step is to complete an initial evaluation of the asset.
A. Site Property Visit: While NNN lease properties are often evaluated based on the credit-worthiness of the tenant, the lease itself and historical performance information, it is still important to visit the site in person as many nuances may exist in the site area that are not evident in the "on-paper" analysis.
B. Legal Analysis: Lease restrictions, easements, and encroachments can impact the value of the real estate site by restricting what you can and cannot do with the site in the future. The vacated value of a NNN investment is the piece of real estate itself. Thus, a highest and best use analysis will provide insight into the viability of the site if and when the tenant chooses to vacate.
Step II: Evaluate the Tenant
When evaluating NNN investments, perhaps 30% of the value of the asset is driven by the location of the real estate while the other 70% is driven by the credit quality of the long term tenant. Financial statement analysis and credit rating services are vital sources of information in tenant evaluation. A corporate lease guarantee means little without substantiating the likelihood that the tenant will perform on its lease obligations. The higher the risk that a tenant may not be solvent over the long term, the higher the cap rate should be.
How can you underwrite tenant risk?
If the tentant is publicly-traded, the credit rating can be identified through a number of sources such as Standard & Poor's and Moody’s.
If the tenant is privately-held, then the following documentation should be requested from the seller:
• Tenant Credit Report: Request and review Tenant credit profiles from one or more of these types of reporting agencies: D&B, Equifax
• Tenant Recent Sales History
• Tenant Annual Financial Reports and Tax Returns
Step III: Evaluate the Lease
The lease is the most important piece of information associated with buy and hold investment analysis. Make certain that the lease has no ambiguous terminology. It is important to read every word of the lease document and request your attorney to do the same independently. Once the review has been completed, it is vital to compare notes to make sure that you understand what you as the landlord need to cover, agreed-upon rental increases, and under what conditions can a tenant terminate the lease.
Triple Net Investments (NNN) investments that have been carefully structured and underwritten provide an outstanding value proposition. However, these are highly long term investments. As such, before you commit capital to such a long-term investment vehicle it is vital to further study this asset class and complete a thorough due diligence analysis.
Standard & Poors provide Credit Ratings for most large tenants.
You can search for current S&P rating information using an entity name, a standard identifier such as CUSIP, CINS or ISINS number, or a Fund name.
Moody's also provide a similar parallel credit rating service, but while their ratings use similar symbols there are significant differences. The table below compares the various symbols.
Hoovers also provide information which may be useful to the user.
Extremely strong capacity to meet financial commitments.
Very strong capacity to meet financial commitments.
Strong capacity to meet financial commitments, but susceptible to adverse conditions.
Adequate capacity to meet financial commitments, but more subject to adverse economic conditions.
Less vulnerable in the near-term but faces major ongoing uncertainties in the event of adverse business, financial and economic conditions.
More vulnerable to adverse business, financial and economic conditions but currently has the capacity to meet financial commitments.
Currently vulnerable and dependent on favorable business, financial and economic conditions to meet financial commitments.
Currently highly vulnerable.
A bankruptcy petition has been filed or similar action taken but payments or financial commitments are continued.
Payment default on financial commitments.
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