Are Residential Properties & Apartment Complexes Better than NNN Property Investments?

May 13, 2021 | Blog, CRE - Commercial Real Estate, Investment Properties, Multifamily, Triple Net - NNN or Net Net Net

Are you a new or seasoned commercial real estate (CRE) investor looking for multifamily property investments because you feel they provide the most ROI and highest resale value? You’re not alone. Many investors have the impression that residential, multi-tenant, and apartment complex properties are a better choice with higher returns than triple-net lease (NNN) property investments; however, that is not the case.

In this article, we challenge the age-old myths about why residential and multifamily CRE investments are better than NNN investments and share why NNNs may be your wisest choice.

Stacks of money in a briefcase

Challenging the Myths of Multi-tenant CRE as a Better Investment than NNNs

Myth #1: I’ll Make More Money with Residential or Multi-tenant Properties than with NNN Investments

Before you make the leap into multi-tenant commercial real estate, let’s talk about the myths surrounding single-tenant, triple-net investing, especially the perception that NNN properties do not offer the high returns that residential, multi-tenant, and apartment complexes offer.

When you look at a listing for apartment buildings or duplexes, you’ll often see cap rates of 10.00–12.00%, sometimes even a little higher. By contrast, on a triple-net lease property, you may see a cap rate of 5.00–7.00%. On the face of it, it does seem like residential and multi-tenant property investments would provide a higher return on investment (ROI).

However, when you factor in paying the taxes, insurance, property management fees, operational costs, building maintenance, and common area maintenance expenses; the high-maintenance nature of multi-tenant properties, and the tenant turnover, that 10-to-12% return begins to diminish. Add inflation, the fluctuating costs of goods and services, and any unforeseen or underestimated costs, and the pro-rata share of estimated expenses paid by your tenants is often less than what you’re actually paying.

In the end, that 10.00–12.00% cap rate often becomes a 5–8% internal rate of return (IRR), with lost time, frustration, and real estate management that chips away at your freedom.

The opposite happens with NNNs. When factoring in the expense-free, maintenance-free, and management-free nature of the property, plus the tax opportunities and long-term, incremental rent increases, an advertised cap rate of 5–7% could ultimately become and an 8–12% IRR.

Let’s get into how this works in the next section.

Businessman drawing an exponential curve of a progress in business performance, return on investment - ROI, on a virtual screen presentation.

Myth #2: Cap Rate and Cash-on-Cash Return are Lower for NNN Investments

Because advertised cap rates are typically lower for NNNs, the perception is that the cash-on-cash (CoC) return for high-quality NNN lease properties is lower than that of residential, multi-family, or multi-tenant property investments.

In fact, once you factor in all the expenses and the time-costs of owning high-maintenance, high-risk properties (as outlined above), no-maintenance, lower-risk NNNs come out on top.

  • If you secure a mortgage for any CRE property, the interest rate on the debt has more to do with the cash-on-cash return and long-term value of the investment, not the cap rate.
  • NNNs tend to benefit from lower interest rates than higher-risk real estate. Low interest rates create an interest-to-yield rate spread that allows you to potentially pay down the loan and increase your cash-on-cash (CoC) return with positive leverage.
  • In an all-cash transaction, the cap rate simply compares the purchase price of the property to the income (rent) it generates. When paying all cash for an absolute NNN property, your return on investment is simply the cap rate, or rent received, as there are no landlord expenses.
  • With absolute NNN properties, the fact that you do not pay taxes, insurance, maintenance, management costs, or anything else, plus the tax opportunities and incremental rent increases over the 10- to 15-year lease term, an advertised 5.75% cap rate could amount to an 8–10% internal rate of return (IRR).

commercial real estate loan written on a pad of paper

Myth #3: With NNNs, Leveraging Significantly Increases Risk & Investment Value Remains Flat

If you obtain debt to purchase a NNN property, your CoC could end up exceeding the cap rate return of an all-cash purchase. This is known as “positive leverage.”

Low interest rates create an interest-to-yield rate spread that allows you to potentially pay down the loan and increase your cash-on-cash (CoC) return with positive leverage. The combination of cap rate and interest rate terms creates this positive leverage opportunity and lowers risk, which makes it beneficial to explore financing your NNN purchase.

Positive leverage may also create the opportunity to acquire additional assets due to a lower down payment versus an all-cash purchase. There is lower risk involved in leveraging a NNN investment, as these properties rarely lose value and typically sell fast at top dollar.

Additionally, most NNN lease properties are located on prime parcels of land or in developing areas, which usually increase in value over the 10- to 15-year lease term should the tenant vacate at the end of the lease and you decide to sell.

If you choose to sell the property before the end of the lease term, the value of the real estate will depend on the tenant’s creditworthiness, location, and the remainder of the lease term, just like any other commercial real estate.

Since NNN properties are tenanted to high-credit companies who guarantee the lease, and lease extensions and rent increases are built-in for the remainder of the lease term, if or when you decide to sell, a healthy return on investment is most likely.

As for the CoC and investment value of residential rentals and multi-tenant buildings, values fluctuate significantly and your income is at the mercy of the economy and whether tenants pay their rent on time or at all, if they vacate early, and how much maintenance is required on each unit when they leave. If you want to sell, these properties typically require a buyer who wants to take on the risk, the maintenance, the costs, and the unpredictability of the investment, which is much harder to find.

Graphic of building with money comin gout of roof

Myth #4: Owning NNNs Means Loss of Diversity, Which Negatively Affects Investment Portfolio

One of the biggest arguments we hear about why NNNs are not as good as traditional CRE is the loss of investment diversity. This could not be farther from the truth. Within the NNN market, there are more ways to diversify than there are with residential rentals, multi-tenanted properties, and apartment complexes. Triple-net investments allow you to diversify with asset type, tenant type, location, lease terms, and lease duration.

For example, you could own an auto parts store with a 15-year, modified absolute net lease, a retail pharmacy with a 15-year absolute triple net lease, a 20-year ground lease, and a 15-year, absolute-net, sale-leaseback on a manufacturing facility. Another way to diversify would be to own four absolute, 15-year-lease NNN Dollar General properties in different states and location types: rural, urban, suburban, and industrial.

No matter how you choose to diversify within your NNN portfolio, remember, with any NNN lease, the rent is guaranteed to be paid for the lease term by a high-credit company, even if a location should close or relocate. In this scenario, you would not continue to receive income for the lease term with any other type of commercial real estate.

NNN Lease Property & Tenant Types

  • Retail pharmacy/drugstore
  • Auto parts store
  • Dollar store
  • Convenience store
  • Fast-food/QSR restaurant
  • Medical clinics
  • Dental clinics
  • Sale-leaseback properties
  • Ground lease parcels

Owning a mix of NNN property types along with other investment vehicles provides low-risk stability and a cushion against potential ups and downs, as well as the rewards of consistent monthly income, a steady return on investment, immediate and long-range tax advantages, freedom, and peace of mind. – Jason Simons, VP Westwood Net Lease Advisors

Commercial Lease agreement with money on a table.

Myth #5: NNN Investments Aren’t Really Maintenance-Free and Expense-Free

Yes, absolute NNNs really are completely maintenance-free and expense-free. An absolute NNN lease property is an investment in which the tenant agrees to a long-term lease that requires paying the “net” amount for three types of costs – net real estate taxes on the leased asset, net building insurance, and net common area maintenance (CAM). Most often, these tenants are investment-grade corporations such as Dollar General, Walgreens, or McDonald’s, who perform their own maintenance and pay for all capital expenditures. The landlord is responsible for nothing.

As the investor, you are protected from unpredictable and rising operating costs, leaving you completely free to carry on with life and collect monthly income with zero responsibility.

There are also properties with modified absolute NNN or double-net-plus (NN+) leases. These leases often require landlord responsibility of roof, structure, and parking lot. Depending on the age of the building or what the inspector finds during due diligence, purchasing a modified NNN or NN-plus property is often as responsibility-and-expense-free as an absolute NNN.

For example, we recently had a client purchase a NN+ Dollar General that was built in 2011. The inspection reported a dent in the side of the building, which became a negotiating tool. The dent was fixed by the seller, and the roof had already been replaced, so the buyer would most likely be free of any roof, structure, or parking lot expenses for the remainder of the lease, thereby creating an absolute triple-net level of responsibility.

The Benefits of NNN Investing vs. Multi-tenant CRE

  • Minimal learning curve.
  • Work with a specialized NNN advisor, own it, and forget about it.
  • No maintenance, operations, management concerns/costs.
  • Low-risk investment, easy income, asset stability.
  • Recession-resistant, long-term returns.
  • 10–20 year, corporate-backed lease guarantee.
  • Consistent monthly income for decades.
  • Tax opportunities and other benefits can increase IRR.
  • No responsibility, own anywhere, CRE diversification.
  • Tangible asset, possible financial leverage.
  • Build wealth, preserve capital.
  • Earn income in retirement or while you work with no worries.

To Wrap it Up – Why NNN Investments are Better than Residential Rentals, Multi-tenant Properties & Apartment Complex Ownership

When our clients (often veteran CRE investors) experience the income stability and lifestyle freedom of NNNs compared to residential rentals, multi-tenant properties, and apartment complex ownership, they usually end up owning several. Many sell all their high-maintenance properties and trade-up using the 1031 exchange, deferring all capital gains taxes.

As NNN lease advisors, Westwood educates, advocates, and helps new and seasoned real estate investors like you evaluate which NNN lease investment will provide the income and return on investment you are hoping for, and ensure you know what your NNN financial future will hold.

No-Obligation NNN Consultation

If you already own residential rentals, multi-tenant properties, or apartment buildings, it may be time to let go of the headache of high-maintenance investments and earn a comparable ROI and a stable monthly income without the hassle. Be sure to look for next week’s blog when we discuss how easy it is to transition from high-maintenance, residential, multi-tenant, and apartment complex real estate ownership into NNNs.

If you want to learn more in a one-on-one conversation, our no-obligation consultations are free – contact an advisor today. 314-997-5227


 

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