When it comes to commercial real estate (CRE) investments with the highest returns, a lot of buyers look for multitenant properties with as many tenants as possible, assuming they provide the most profitable outcome. However, while multitenant properties offer a higher advertised cap rate and seemingly higher ROI, triple net (NNN) lease properties have few, if any, landlord expenses and offer multiple tax opportunities for a comparable and sometimes higher ROI.
Triple net investments are profitable due to:
- Few or no landlord responsibilities or associated costs
- Predictable ROI and potential 7–10% internal rate of return
- Tax opportunities
- Diversification
NNN Lease: Few or No Landlord Expenses or Responsibilities
A NNN lease not only places the responsibility of paying real estate taxes, maintenance, and all insurances onto the high-credit tenant, but most often, the tenant pays all common area maintenance (CAM), property management, utilities, and any other expenses. Therefore, when you own an absolute NNN property with zero landlord responsibility, you are free to work and enjoy life without the headaches and high costs associated with property ownership.
NNN Return on Investment (ROI) & Internal Rate of Return (IRR)
In commercial real estate, properties with the highest return on investment (ROI) are usually those with the highest number of tenants, such as apartment complexes and office buildings. Single-tenant triple net lease properties are the exception. These high-credit franchises or multibillion-dollar tenants, such as Dollar General, Taco Bell, and Walgreens, sign long-term, guaranteed leases that offer fixed monthly income and periodic rent escalations to hedge against inflation. This provides steady cash flow for up to 20 years or more if extension options are exercised, strong cash-on-cash returns (pre-tax cash flow), and a typically expense-free ROI (ongoing profit).
The internal rate of return (IRR), which is the yearly return on equity after adjusting for expenses, rents, loan payments, and taxes, is also comparable to multitenant, high-maintenance real estate, even though the advertised cap rate is typically lower. How? If you own an absolute NNN that’s 100% expense-free and you write off depreciation and interest, a 4.50–6.00% cap rate can become a 7–10% IRR.
Then there’s the 1031 exchange. When utilized to trade a high-maintenance or underperforming property for a NNN property, you can defer 100% of the federal capital gains tax and the 25% depreciation recapture tax on the sold property (if you’ve taken depreciation). The extra capital, which could be six figures or more, could provide the opportunity to purchase more than one NNN for greater profitability.
NNN Tax Opportunities
Most commercial real estate investments offer tax opportunities. However, triple net lease properties benefit directly without the extremely complicated accounting. For example, absolute NNN lease properties, such as Dollar General, KFC, and Aspen Dental, are completely expense-free. You simply own the property, and if there’s a mortgage, you benefit from the tax opportunities offered on interest. Depending on your tax situation, you may also benefit from using one type of depreciation or combining those that can be combined, such as cost segregation depreciation and bonus depreciation.
Cost segregation depreciation (CSD) is significant depreciation of non-structural improvements, such as indoor and outdoor lighting, HVAC systems, parking lot improvements, and landscaping, over five, seven, or 15 years, versus 39 years. This helps you preserve capital, realize immediate cash flow, and achieve considerable tax relief on new and existing buildings. Bonus depreciation allows for a 100% deduction of leasehold improvements in one tax year, until December 31, 2022, then it becomes an 80% deduction in 2023. Gas stations with convenience stores are usually candidates for bonus depreciation.
Be sure to speak with your CPA or real estate attorney before you purchase any commercial real estate to determine which tax code(s) would be applicable to your situation.
Diversification of NNN Portfolio
To balance risk and reward in the stock market, you choose different companies to invest in, various asset classes, and a selection of investment types. You can do the same within your triple net investment portfolio.
It may seem as if NNNs are “all the same” but there is a difference between tenants, lease types, lease terms, locations, asset classes, and tax opportunities, each with different characteristics and profit potential.
NNN Tenant Type
- Tenant types vary from multibillion-dollar retail, child care, and service-based brands (7-Eleven, Guidepost Montessori, Dollar General, AutoZone) to high-credit fast-food franchisees (Taco Bell, KFC, Starbucks) and manufacturing and industrial sale-leaseback tenants.
NNN Lease Type
- You can own absolute NNN lease, regular triple net lease, double-net plus (modified NNN), and ground lease properties. Most major brands guarantee the lease for the lease term, so you can count on a reliable income stream no matter what happens to the business.
NNN Lease Term
- Each property can have a different lease term, i.e., remaining years on an original lease (5 to 10 years), a full-term lease (15–20 years), or in the case of a ground lease, up to 99 years.
NNN Location
- Location is a big diversification factor. For example, you can own NNNs in prime locations in different midwestern states where the population is growing, and cap rates are a bit higher. You can own in rural communities where the tenants have strong sales. Or you can own NNNs in prime locations in popular states or cities, knowing they may have slightly lower cap rates but a potentially higher resale value.
- There are also US states that do not levy income taxes or capital gains taxes, and others that levy minimum taxes, which can increase your profitability, depending on the state in which you live and your tax situation.
NNN Asset Class
- While most NNNs will be Class A properties, owning properties with A, B, and C ratings provides a wide range of risk and reward. You can have a portfolio that includes some of the best buildings in the best locations with the highest rent and others in the lowest class (C) with the lowest rent but with the highest value-add opportunity (NNN fulfillment center or flex-space, for example).
NNN Tax Opportunities
- Tax opportunities can help you diversify by freeing up significant capital to reinvest. You can concentrate on buying buildings that are eligible for CSD or use the 1031 exchange by turning one large, cost-heavy property into two or more responsibility-free NNN lease investments.
It surprises most CRE investors when they realize how many ways in which triple net lease investments offer the flexibility to create a balanced portfolio with unexpected profitability and without the ownership headaches.
Other NNN Factors that Lead to Profitability
Triple net lease tenants typically sell essential goods and services, like consumer staples, medical services, pharmacy items, auto parts and collision services, gas and convenience store items, child care services, and car washes, which has shaped a strong NNN lease market, even in the face of economic uncertainty.
In fact, NNN tenants are usually major brands that thrive in any economic situation. They have adopted the latest technology and AI to stay internet-relevant and can adapt to just about any situation, such as a pandemic. These companies are growing, adding locations, and offering real estate investors like you passive income shaped to fit your geographical preferences and financial objectives.
Moreover, triple net lease properties can appreciate faster than other types of CRE, and of course, the real estate on which they sit is tangible and valuable.
To Wrap it Up – NNN Profitability
As you can see, NNN lease investments provide strong yields, tax opportunities, and long-term, low-risk income predictability – in many cases, steady cash flow for 20 years or more with little to no responsibility or expenses. Profitable, single-tenant, triple net properties are typically easy to sell and/or re-tenant, and when combining the tangible value and lease value with tax opportunities, you can build worry-free wealth for years to come and live the life of your dreams.
Contact Us for a No-Obligation NNN Conversation
If you’re ready to search for your first or next NNN property, keep in mind they are highly desirable, often difficult to locate, and sell fast, that’s why engaging Westwood Net Lease Advisors is your best option. We communicate with our vast nationwide network of brokers, sellers, and developers daily to learn of pre-market, off-market, and developing properties before they’re advertised so you don’t miss a single opportunity.
Throughout the process, we represent you and your best interests, from the before the property search through closing and thereafter, offering objective advice, education, knowledge, and advocacy – all at no cost to you. Contact us today for a no-obligation consultation, 314-997-5227.
