There are various triple nets that can be used for the 1031 exchange. Whether it’s a restaurant or auto-parts store, pharmacy or a regular retailer, each type of triple net property have their positive and negative aspects.
Some of these types are special-use buildings designed especially for the tenant such as at McDonald’s or Burger King. But auto parts stores are other big-box retailers that can be used for various businesses which don’t require a large amount of future capital expense to redo the existing building.
What Is The Best Type Of Tenant For A 1031 Exchange?
When deciding which type of tenant to purchase for a 1031 exchange, you need to keep in mind a few simple factors such as:
- Credit of the tenant
- The length of the triple net lease
- The bumps in that net net net lease.
But also the most important of all, consider the type of building that may lend itself to other uses without much difficulty.
Another very important issue is the INDUSTRY that the tenant is representing. Before choosing, you need to consider some industry related questions:
- Is the tenant in an industry involving consumers interested in childcare?
- Or is the tenant interested in the industry concerning senior care or pharmacy?
- Maybe the tenant is a retailer that just provides products that a normal customer DOES NOT have to acquire?
- How about restaurants that are optional to go to and NOT the absolute necessity?
You also need to consider the TRENDS in the economy such as:
- Weakness in electronics
- Exercise places
- Fast foods that don’t serve healthy meals…
These all factors are questionable when deciding to purchase for a 1031 trade.
What Lenders Know About 1031 Exchange Trade?
Lenders are picky about location, quality of the tenant credit or can the building be used for other purposes (such as whether the city is a tertiary area). Those are some things that make up the decision by the lender to provide proper financing for the 1031 exchange trade.
The lender can make a substantial difference when quoting rates and terms based upon the selection made by the borrower of the type of property for the 1031 exchange. So price of the property or cap rate may not be the only consideration when viewing, but the overall returns based upon loans and purchase price versus net income the property throws off.
“Location, Location, Location” Is It Enough For The Tenant?
Location, location, location has always been stressed in commercial real estate. But considering only this principle is NOT enough because the selection of the type of tenant and the type of building the tenant is occupying can be also crucial in the final internal rate of return when the property is sold sometime in the future.
After all, the yearly net income does not dictate what the final return on investment will be.
The only determining factor of what the internal rate of return will finally end up being, is based upon the sale of the property. So if the investor is basing his or her sole judgment on just the net income and not taking in consideration future sale, when the present tenant may not occupy the property in the future, a big mistake in judgment can occur!
After all, collecting rent for many years and losing back the gain at the end, can be very distressful if not considered up front.
As an example, if your tenant shall leave, you need to have in mind some basic things like:
- Lease up time
- Leasing commissions
- Capital improvements for the new tenant that must be evaluated and
- Calculation of the new rent, so that the investor is not going backward from the start.
In addition, the new tenant may not be as strong as the last tenant, so that when selling cannot be dictated the same cap rate the present owner paid on day one.
