When buying or selling a net lease property, it’s essential that all the facts add up, and unless you’re a seasoned professional it’s easy to make a mistake that can cost you tens of thousands of dollars.
Here are some of the most common mistakes investors make when doing net lease deals.
Mistake Number #1: Failure to Evaluate Tenants
Many investors assume that because a property is a net lease, the tenants must be high-quality tenants as well. In reality, net lease tenants run the gamut from mom and pop stores to company-backed franchises with branches around the country.
The first step you’ll want to take after confirming the lease is actually a net lease, is to check and see if the tenant is an investment grade tenant.
Investment grade tenants are national companies that are large enough to maintain good credit ratings. These credit ratings are determined by Standard and Poor, Moody’s, and Finch, and are used to help investors determine the likelihood of the company being able to honor their debt obligations.
The lower the credit rating, the higher the risk of default, and the higher the cap rate, since a property with a less stable tenant is a riskier bet for the investor.
Investment grade tenants have a credit rating of at least BBB-, which is considered medium risk. However, although technically tenants with a BBB- are considered investment grade, there is a world of difference between a tenant with an A rating and one with a BBB- rating… so relying on the credit rating alone isn’t a smart idea.
It’s essential you also review the company’s financial statements before you purchase the property in order to assess the risk they present to you as a potential owner. When you purchase a net lease property, you’re betting on the ability of the tenant to pay you for the next 10 or 20 years.
Mistake #2: Assuming Sellers Will Reveal All of a Property’s Problems
Not all sellers are willing to disclose all the problems a property may have. That’s why it’s essential buyers do extensive due diligence to determine hidden problems. Don’t rely on inspections performed by the seller; it’s not uncommon that inspections or reports somehow fail to reveal serious problems with a property.
When you do question a seller about the property, keep a written record of all communications. This will help prove if a problem that was discovered by the buyer may actually be the responsibility of the seller, or it can help you negotiate a lower price for the property.
Occasionally buyers have discovered a problem so severe the property isn’t fit to be sold; often this occurs due to hidden environmental problems that either can’t be repaired or can be fixed only after investing immense sums of money.
Mistake #3: Failure to Check Tenant Leases Thoroughly
Although the seller might claim a property is a net lease, as the buyer, you must take the time (or hire an expert) to carefully comb through all the fine print of a tenant’s lease.
Cancellation clauses, fixed option rents, caps on pass-through expenses and more can all turn a potential money-maker into a dead weight that can drain your portfolio of net profits.
Mistake #4: Not Having the Right People On Your Investment Team
Some investors assume finding a great net lease property can easily be accomplished with a quick search on one of the popular sites for commercial real estate.
The truth is, the vast majority of good net lease deals are not only off-market but come about through nurturing a network of professionals who deal day in and day out with serious investors.
This is particularly true for trophy properties, whose owners are not interested in dealing with every Tom, Dick, and Harry who wants to buy the property.
Here’s what usually happens: a broker gets a call from an investor who’d like to sell their property. That broker contacts their own clients, and if they themselves don’t have a buyer, contact other brokers in their network who might have an interested buyer.
There might be as many as twenty or more offers, and since everyone knows the value of the property, most of the offers will be for the full asking price of the property or higher.That’s fine with the seller of course, but also for the buyers since they know the value of the property will increase over time.
During this time, the broker is there to help shepherd the investor through the deal safely and successfully. An experienced broker is there to work with you by asking the right questions to a seller, writing an LOI that is likely to be accepted by the seller, working through any issues that come up so the deal doesn’t fall apart, and much more.
The truth is, when you’re working on a deal worth millions of dollars, it doesn’t make sense to try and scrimp; you’ll save time, energy, and hundreds of thousands of dollars by making sure you have qualified people on your investment team.