Building a commercial real estate investment portfolio isn’t a one-size fits all option.
When you’re considering what type of commercial income property to invest in, you’ll first need to review your investment goals, then choose a property that will help you achieve those goals according to the level of risk you feel comfortable with.
However, regardless of your investment plans, it’s always a good idea to DIVERSIFY your portfolio. One of the best ways to do that is to invest in investment grade net leases.
Investment grade leases involve leases to tenants with a credit rating of BBB– or higher. BBB- represents a “good” credit rating, as determined by Standard and Poor, Moody’s, and Fitch, and indicates the ability of a company to meet its financial obligations.
Generally this credit rating refers to large national companies, as corporations are large enough to maintain strong credit ratings and can be easily tracked by rating agencies. Investment grade credit ratings establish the relative risk of default for a particular company; the higher the credit rating, the lower the default rate.
Thus, companies with a rating of AAA are considered low risk, and average a 0.52% default rate. BBB- companies are considered medium risk, with a default average of 6.64%. Below BBB- are the highest risk companies, which are given a “junk” status.
Net leases range from single net to triple net (NNN) leases. The definitions of various types of net leases are explained in a previous post. Triple Net Leases offer the most attractive terms, as these are properties with 10 – 25 year leases, no management responsibilities, with the tenant paying all expenses associated with the property.
RISKS AND BENEFITS OF INVESTMENT GRADE NET LEASES
1. Stable Income
Investment Grade Net Leases are typically backed by strong corporations that are able to honor their obligations even in a difficult economy. Leases are long-term, and are structured as flat rent or fixed increase, allowing the investor to count on a set amount of capital per month.
In addition, net lease properties are not affected by short-term market fluctuations, which ensures the investor has a commercial income property that is stable over the long-term, contributing to his investment portfolio.
Some critics point out that although net lease properties provide some growth, there isn’t a major rise in prices over the years. On the other hand, the fixed rate of return offers a cushion during economic downturns, ensuring a higher yield than corporate bonds while enjoying the protection of investment grade tenants.
2. Easy to Manage
Long term net leases are SIMPLE to manage, since most maintenance, insurance, and operational expenses are paid by the tenant. This leaves you free to spend time with other investments, while continuing to receive a set income per month from the property.
However, investors considering the purchase of an already occupied property would do well to note the length of time remaining on the lease. If the lease is due to expire, it will be your job to find a new creditworthy tenant. Not only does this mean you will be responsible for paying for debt on an empty property, it also means that you will incur the costs of preparing the property for a new tenant.
3. Attractive Cap Rates
Commercial income properties that are also net lease properties offer attractive cap rates in comparison to other types of real estate investments. These single tenant properties are, on a cap rate basis, priced lower than standard real estate investments.
Prices for net lease properties do tend to rise towards the end of the lease, since a large portion of their value is based on their income stream. However, you can avoid this pitfall through due diligence on a prospective property.