It comes as no surprise that interest rates are higher than they’ve been since 2008. In November, the U.S. central bank raised interest rates for the fourth time in 2022 to a range of 3.75–4%. This “benchmark” interest rate range influences borrowing from most lenders, such as banks and mortgage companies.
Will there be more rate hikes? The Fed says yes, but the plan is to implement a less restrictive policy, stepping down December’s increase to half a point, with even smaller hikes in 2023, until inflation returns to an average of 2%.
Triple net (NNN) lease buyers waiting to invest, we can assure you, even with higher interest rates, NNNs are one of the lowest-risk investments with the most reliable income and overall returns of any investment type.
Here’s what you need to know.
Planning on NNN Financing? Avoid Further Interest Rate Increases & Benefit from Reliable Monthly Income
When triple net lease investing, rising interest rates and fluctuations can be favorable, slightly affect your commercial mortgage plans, or not matter at all. Since many NNN properties can be purchased between $1M and $10M, much less than a high-maintenance apartment complex or office building, NNN investors often use all cash or finance just a portion of their investment, which makes interest rate hikes less of an issue, though it can act as a short-term deterrent.
If you need financing to NNN invest, to avoid future interest rate hikes and take advantage of negotiating power and tax opportunities, consider investing sooner than later. Rather than letting your money sit idle due to uncertainty, a steady NNN lease investment could help you preserve wealth and passively add to your monthly earnings. Locking in the going interest rate (approximately 5.75–6.25% give-or-take depending on the property) before the next rate hike would help improve your cash-on-cash (COC) return (see calculation below).
The Benefits of NNN Investments in an Inflationary Economy
- Triple net leases are typically backed by investment-grade, multibillion-dollar companies or high-credit franchisees that offer a lease guarantee no matter what is happening with their properties.
- Lenders are keen to mortgage triple net properties and often extend more favorable interest rates and terms when compared to non-net-lease commercial real estate.
- You can depend on 10 to 15 and sometimes 20 years of reliable monthly income with increasing returns.
- These tangible assets offer the security of monthly income backed by a lease, hassle-free cash flow, and possible leverage.
- Absolute triple net leases liberate the landlord of all maintenance, management, and expenses.
- NNNs are typically easier to resell; you could, in effect, repeatedly sell and buy triple net properties in 1031 exchanges to maximize your wealth for years to come.
- Utilizing available tax benefits and other financial factors, there’s the potential to turn a 4.50–5.50% cap rate into a 7–10% internal rate of return.
No other investment type offers as many benefits to the investor in an unpredictable economy.
“A recent study found commercial real estate performance has been good during periods of high inflation and returns are much more closely correlated to growth than inflation.” — Greg MacKinnon, Research Director, Pension Real Estate Association
What About the Cap Rate to Interest Rate Spread?
First, it’s important to note that an advertised cap rate on a triple net lease property is calculated on an all-cash basis. It signifies the level of risk and is just one measurement of the equity return on investment. Other calculations and variables also affect a triple net investment’s outcome, including the cap rate spread.
The “cap rate spread,” or cap rate to interest rate spread, measures and compensates commercial real estate investors for the additional risk assumed by taking on debt. If the spread widens, as it has over the last few years, investors are more highly rewarded.
“When interest rates change, cap rates tend to be slow to catch up, and when they finally do, it’s usually only partially. In the 13 years I’ve been a triple net lease advisor, even during the Great Recession, NNN cap rates have stayed reasonable and unchanged for long stretches of time, mostly between 4.50% on the low end and 7.00% on the high end, with some exceptions, of course,” says Chris Schellin, President of Westwood Net Lease Advisors.
“Currently, there is a larger gap than we’d like to see in the interest rate to cap rate spread, however, cap rates will gradually increase as the supply and demand curve shifts. With a bit of nudging, we are seeing cap rate and purchase price negotiating power as the market moves from a seller’s market to more of a buyer’s market,” adds Schellin.
Cash-on-Cash (CoC) Return & Interest Rates for Triple Nets
Your CoC return is the amount of cash you receive (rent minus debt service) divided by the amount of cash initially invested. When you take out a commercial loan to finance your triple net property, the interest rate on the debt can affect your CoC and the long-term value of the investment. With all things being equal, a higher interest rate can lower your CoC return, and a lower rate can increase it.
- For example, if rent earned is $110,000 and your debt service is $50,000, your cash flow is $60,000. If your down payment was $1,000,000, your CoC return would be $60k/$1M = 6% cash-on-cash.
- If the interest rate were half a point higher, the $50,000 in the example might become $55,000, which would give you a 5.5% COC return instead of 6%.
That being said, NNN properties tend to carry a lower interest rate than gross lease properties due to several key factors: the tenants are either a high-credit company or an investment-grade corporation, the properties are usually in prime locations or the best locations for their target audiences, and the triple net lease is typically guaranteed, so the lender carries the least amount of risk, as do you.
Cash Flow Related to Debt Service or Debt Yield
Another figure you need to know when securing a commercial mortgage is the cash flow related to debt service or your “debt yield.” Lenders must ensure the property’s net operating income (NOI) covers its operating expenses and debt payments by about 1.25 times (the debt service coverage ratio – DSCR). When interest rates increase, so too does the amount needed to cover debt payments.
In Any Economy, Triple Net Commercial Real Estate Offers Lowest Risk
Historically, no matter what the economy is experiencing, triple net property investments are known to carry the lowest risk in the commercial real estate market. These property types (retail, medical, child care, fast-food, QSR, auto parts, drug stores, convenience stores) have recently come through the worst modern-day economic and health-related crises, and they are stronger for it.
Triple nets offer predictability and surety of income, tax opportunities, and diversification within the market that builds wealth. Their reliability keeps mortgage interest rates lower than gross lease property rates and cap rates consistent, in the range of 4.50–5.50%. They offer a potential IRR that rivals other types of investments (7–10%) without the daily worry of maintenance and value fluctuations.
To Wrap it Up – What it Means for You: Interest Rate Increases on Triple Net Lease Property Investments
Despite interest rate increases, NNN lease property investing remains a solid choice. Your CoC may be affected by a higher interest rate, or if you’re an all-cash buyer, it may not matter. Fortunately, there is a slight shift toward a buyer-friendly market with minor cap rate increases and price negotiations, which helps every type of NNN buyer.
Additionally, major brands like Dollar General, 7-Eleven, and Taco Bell are planning to add new services and locations, 1031 exchanges remain a top investment strategy, and valuable sale-leasebacks are growing in popularity. In any economy, steady NNN lease properties will continue to be a low-risk, financially strong investment option.
Begin Your NNN Property Search Today, at No Cost to You
Despite interest rate fluctuations and economic fears, triple net lease property cap rates have not changed dramatically in decades. This allows us to confidently satisfy both the most conservative and aggressive triple net lease investors, and instill peace of mind in those who are searching for their first or next NNN investment.
To locate the most ideal triple net property for your financial and lifestyle goals and have the best buyer representation, from before the property search through closing, engage an expert triple net lease advisor from Westwood Net Lease Advisors. We’re here to help you with every step of the process, including sourcing reputable lenders with competitive interest rates, at no cost to you. Contact us today, with no obligation, to learn more. 314-997-5227
