If you’re a serious investor, you likely prefer a diversified portfolio that spreads out risk between high and low risk investments.
And while the exact proportion may vary depending on your investment goals, the stage of life you’re in, and other factors, a portfolio that includes a high-value property and produces steady returns with little management is at the top of any smart investor’s must-have list.
Triple net lease properties fit the bill nicely.
Triple net properties, also called NNN properties, are low risk investments with predictable cash flows. Capitalization rates are higher than multifamily apartments even in the same area, which means greater leverage as well as higher cash flow. Leases are structured so that the lion’s share of the responsibilities and expenses of managing the property fall on the tenant.
Thus tenants pay all on-going expenses, including:
- maintenance, and
- most capital expenditures.
Renovations and landscaping also fall to the tenant, who often chooses to rebuild the property to suit tenant-specific needs.
This results in very little management for the owner, who instead of having to put up with middle-of-the-night phone calls from tenants, or deal with yet another management agency’s below-par performance, is now free to use the time for other investments.
In return, the tenant receives a long-term lease, generally between 15 – 25 years, in a high-traffic area. This means investors avoid vacancy costs and the accompanying hassle that finding a tenant entails.
When buying a triple net property, investors would be wise to note where in the lease term the present tenant is. If it is towards the end, this means you as the new owner will be left with the responsibility of either negotiating a new lease with the present tenant, or finding a new tenant altogether.
At the same time, it also gives the new owner a chance to release the property at a higher rate if the property is in a strong market, which will obviously increase the value of the property in addition to the cash flow.
Keep in mind that the majority of triple nets have built in contractual rent bumps which are tied to the CPI, so even if you purchase a property which is at the beginning or in the middle of a new lease, you will still receive market value on the property.
Tenants are high-quality tenants that are generally part of a franchise, which offers additional security in terms of the stability and financial well-being of the franchisee. Companies such as AutoZone, McDonald’s, The Dollar Tree, and 7-11 are examples of triple net lease properties commonly available.
The low turnover rate not only helps reduce marketing and leasing costs, but also means banks offer better financing terms such as lower down payments and mortgage rates. It also means that your personal credit is less of an issue, since the bank is mostly concerned with the financial stability of the tenant.
One slight disadvantage with triple net lease properties is that they are depreciated after 39 years instead of 27 1/2 as is the case with apartment buildings, which results in a tax shelter that is 30% lower. However, this can be easily avoided by either taking higher interest deductions or by taking advantage of depreciation from another investment.
Another bonus of triple net lease properties is that they are the perfect vehicle for sale/leaseback deals. These occur when a company owns a property that they presently occupy, but decide to sell it in order to raise funds for another venture and/or pay off current debt.
By unlocking the equity of a property, the company is able to favorably change its debt-to-equity ratio, which makes it more attractive to investors and allows the company to use the infusion of cash for operations, expansion, or simply to be put away as reserves. Saab Automobile, for example, used a sales/leaseback to raise $39 million in order to restart production.
For example, let’s say a company owns more than one property, one of which has a balloon payment due to come up that a bank or private lender was unwilling to fund. Selling one property would allow them to pay off both mortgages.
The buyer still receives all the benefits of a triple net lease property, but also has a guaranteed tenant already in place for the property.
As a long-term investment strategy triple nets are unrivaled for their stability, steady cash flow, and ease of management. Although you will still need to do your due diligence to ensure you choose a desirable property with high quality tenants, they are an excellent choice for both new and experienced investors.Tags: cash flow, insurance, taxes, triple net properties