Just entering the triple net lease investment market? This blog will answer the most frequently asked questions about how to qualify for NNN properties, including:
- How do I qualify for NNN property investing?
- Do I need a down payment?
- How do I get financing?
- Does my credit matter?
- Does my home qualify for a 1031 exchange?
How Do I Qualify for NNN Property Investing?
To qualify for NNN property investing with a commercial mortgage, the general rule is that you need a net worth of $1 million or greater. You also need liquidity above your down payment in your portfolio, not including the value of your primary residence. If you do not have $1M, but you make over $200,000 per year ($300,000/year married filing jointly), you may also qualify.
If you are an all-cash NNN buyer, an annual income is generally not a requirement.
Since triple nets have a fairly low barrier to entry, we have investors come from a wide variety of backgrounds seeking the long-term, high-credit, passive nature of NNN properties.– Jason Simon, Vice President, Westwood Net Lease Advisors
Do I Need a Down Payment?
In the single-tenant, triple net market, if you obtain debt to purchase, a lender will usually require a 30–40% down payment and ensure you maintain liquidity in your asset portfolio.
NNN investment financing options and down payment requirements are calculated on a case-by-case basis and driven by factors such as the creditworthiness of the tenant, length of lease, and location.
How Do I Get Financing?
To get financing for a fee-simple triple net:
- Meet the net worth and/or income requirements.
- Have a high credit score.
- Choose a triple net lease tenant with an investment-grade rating or a high-credit company that guarantees the lease.
- Ensure the lease is long-term with rent escalations.
- Select a NNN tenant in a prime location.
Just like buying a home, your credit score will determine if you are qualified to get a mortgage. Once you’re approved to begin the buying process, ultimately your NNN financing terms will be based on the loan-to-value ratio (LTV), which is largely based on the tenant’s creditworthiness, as well as length and type of lease, rent escalations, and location.
The LTV for NNNs is different than any other type of commercial real estate because even if the real estate fluctuates in worth, the property itself will typically maintain its value due to the tenant’s reliability and the fact that the corporation agrees to pay rent no matter what.
When financing, the bank also ensures the net operating income (NOI) from the property covers the debt (about 1.25 times), which is called the cash flow related to debt service.
With absolute triple nets, the cash flow related to debt service is a straightforward calculation, especially when compared to other types of CRE. There aren’t any operating expenses, therefore, NOI is simply the rent received.
Our connections with nationwide lending sources help clients source the best options for their investment goals. – Jason Simon, Vice President, Westwood Net Lease Advisors
TO QUALIFY THE PROPERTY FOR FINANCING, THE LENDER WILL ASSESS THREE KEY FACTORS:
- Tenant creditworthiness
- Lease Term
1. CREDITWORTHY TENANT
When purchasing a triple net using financing, choose an investment-grade tenant, such as Dollar General, Taco Bell, Starbucks, 7-Eleven, or Walgreens, with an S&P rating of a BBB or better. The amount of leverage a bank or credit union is willing to lend is invariably tied to tenant creditworthiness. The stronger the tenant, the higher the leverage.
2. LEASE TERM
Triple net leases tend to be long-term, up to 20 years, which helps greatly with financing. A lender may be more inclined to offer a lower interest rate and a longer-term mortgage on a property leased to a high-credit tenant with:
- A 15–20 year lease in a prime location.
- Periodic rent increases commensurate with estimated inflation.
- The option to extend to the lease in increments with rent increases in those option periods.
Conversely, a shorter lease, five to eight years for example, with higher rents might cause the property to be vacant before the debt is serviced. Higher-than-market rent could create a vacancy and trigger a delay in re-tenanting, which could cause a delay in mortgage payments.
3. PRIME LOCATION
When you begin your property search, look for an essential business in a prime location. Prime locations are usually highly populated or growing areas along major retail arteries or highway exits with strong traffic counts. The best choices are near other consumer staples like the pharmacy, grocery store, auto parts store, and fast-food restaurants.
If the location is in a secondary or less populated market, assess whether it’s accessible and easily re-tenantable when the lease expires. Often, what’s considered a secondary market for some triple net tenants is a prime location for others, such as Dollar General, where 75% of their stores are rural.
Location can be the first clue to a strong potential NNN investment – you’ll rarely find blue-chip companies in underperforming locations. – Chris Schellin, President, Westwood Net Lease Advisors
Does My Home Qualify for a 1031 Exchange?
It is rare to use profits from the sale of a family home to buy a NNN in a 1031 exchange, but it can be done. Here’s how.
A 1031 exchange allows you to defer all federal capital gains taxes on the profits from the sale of an investment property when the profits are reinvested into one or more like-kind, commercial properties.
Though primary residences are not considered “like-kind” to investment properties, a 1031 exchange can be used with personal property if you follow the rules set by Section 121 of the Internal Revenue Code (IRC).
Section 121 states that the profits from the sale of a personal residence can be exempt from capital gains tax ($250,000 of gain for single filers and $500,000 for married taxpayers filing jointly) if you have owned the property for at least five years, lived in it for two of those five years, and rented it at fair market value for two years.
TO SELL YOUR HOME IN A 1031 EXCHANGE, YOU MUST:
- Own your home for at least five years and live in it for two of those five (does not have to be consecutive).
- Move out and rent the property for a minimum of two years.
- Show that you don’t currently live at the home at the time of the 1031 transaction.
- Prove that you’ve been using the property for business purposes.
- Verify to the IRS that you leased the property at a fair market rate.
When considering this option, be sure to plan accordingly and work with a qualified triple net lease advisor who specializes in 1031 exchanges to guide you through the process.
Westwood specializes in 1031 exchanges and takes the burden of the process off our clients. Our decades of experience and 1031 know-how help you get the transaction completed in the time allotted, while you carry on with normal daily responsibilities. Be sure to start the process as soon as possible for a smoother, less stressful transaction.
To Wrap it Up – Are You Qualified for NNN Lease Investing?
Now you know the qualifications for NNN lease property investments. A high net worth, an excellent credit score, and a 30–40% cash down payment – all essential to starting the financing process for a commercial mortgage.
Whether you pay all cash, use a 1031 exchange, or obtain debt to purchase a triple net property, the combination of a creditworthy tenant, a long-term, guaranteed lease, and a prime location significantly impact whether your NNN property remains a profitable investment that’s easy to own, no matter where you live.
If you are interested in learning more about NNN lease investing and the qualifying process, Westwood Net Lease Advisors is here for you. Free of charge, we’ll help you with all the details from before the property search through closing to ensure you purchase the most ideal triple net property for your goals. Contact us today for a no-obligation conversation. 314-997-5227