Single Tenant Net Lease properties are growing in popularity, as more and more investors realize that properties need not be in areas such as New York or San Francisco in order to be profitable.
These investors have discovered that Single Tenant Net Lease properties are just as safe as a bond, and more profitable. Long-term leases, built-in rent increases, and management-free properties make these property types especially attractive to tenants looking to diversify their portfolios with minimal risk.
Single Tenant Net Lease properties include medical buildings, quick service restaurants, dollar stores, pharmacies, or other retail stores. Because they’re spread throughout the U.S., investors aren’t limited to their particular location, and can even purchase a STNL across the country.
However, although single tenant net lease properties offer many advantages, there are several factors investors should be wary of.
Check The Lease Structure
Taking a close look at the lease is essential when you’re considering purchasing a triple net lease property.
That’s because although the definition of a Triple Net is pretty clear – the tenant pays property taxes, insurance, and operating expenses – it’s not uncommon for the actual terms of the lease to be quite different from lease to lease.
In a Single Net Lease property the tenant pays only property taxes, while in a double net lease, the tenant pays both property taxes and insurance. Thus if you examine the lease and discover the owner is held responsible for any of these expenses, then it is not a true triple net lease.
You should also check to see how long the actual lease term is, and if there are periodic rent increases. There is a trend among non-national tenants for shorter leases, without many of the protections offered by traditional triple net leases.
Most businesses are willing to sign a triple net lease because it gives them absolute control over the location, which is crucial for a business where location is “everything.” However, when some of the protections offered to both parties are taken away, a large portion of the benefits disappear also.
Another important feature to check is to see how much time is left on the lease. Since the value of the property depends on the tenant – CAP rate is calculated using the net operating income of the tenant- less time left on the lease means a greater possibility of a tenant failing to renew.
If this is a possibility for the property you’re considering, be sure to take the time to evaluate the value of the building and the raw land. This will tell you whether or not the offering price is reasonable or not.
In the same vein, periodic rent increases also add to the value of the property and ensure that the rent charged keeps up with the market rate. If those are eliminated, an investor could find themselves stuck with a long-term tenant paying below market rate rent.
What Is The Condition Of The Property?
The physical real estate of the property is also important. Be wary of properties used for a purpose that would make the property difficult to lease to another tenant without extensive renovations. Of course this isn’t a problem if there are 20 years left on the lease, but anything less than 10 is a concern.
Another factor that some less experienced investors overlook is the zoning for that particular location. You’ll want to check if the zoning for that area allows you to use the property for a variety of purposes, or if you’re limited to one type, such as industrial.
Similarly, if you do need to provide retrofits, it’s helpful to find out what the expectations are in that area in terms of owner responsibilities.
How Creditworthy Is The Tenant?
National creditworthy tenants with a rating of at least BBB- (S&P) are the standard for premium Net Lease properties.
However if the tenant doesn’t fall into this category, then you’ll need to do investigate whether or not they are financially stable. Ideally it’s best if non-credit tenants that are franchises or local businesses are backed by the parent corporation, which means that the company guarantees the tenant’s lease.
However this guarantee is only as good as the guarantor’s credit, so analyzing the parent company’s credit is essential.
Local tenants present a greater risk. Although they may be willing to pay more, they don’t have a parent company to guarantee the lease in case they go dark, they usually have low cash reserves, and they often don’t invest in improvements on the property.
Not all local tenants are problematic; there are some that might be less risky than others, but you’d need to thoroughly check out their financials and put certain protections into place in order to protect yourself and the property.
Unless you’re an experienced investor, it’s best to stick to national, creditworthy tenants. And since you can purchase a triple net lease property for as little as $500,000, that leaves plenty of opportunities to get started with a net lease property.