What to Look For in Single-Tenant NNN Properties
Published on Nov. 11, 2011
Long-term, single-tenant triple-net properties can be one of the most reliable forms of income- producing real estate ownership, provided that you have the right 1) location, 2) asset, 3) tenant, 4) lease, and 5) ownership structure in place.
This article will address how these aspects of NNN real estate ownership are reflected in each of the primary categories of NNN property.
1) Location: The right location includes the concepts of "replace-ability" and tenant demand. Often, triple-net investors ignore the importance of location, relying most heavily on the strength of the primary tenant to offset a weaker location. While location risk can be diminished by a strong, national tenant, the better investment choice includes a strong tenant in a strong location. The cost of the asset often will be higher for the better location, but the ability to replace a tenant in a location that provides greater demand can provide irreplaceable downside protection.
2) Asset: The right asset includes the right type and condition of the asset as well as the price paid for the asset. Cost and condition are interdependent in real estate. In other words, a low-quality asset may make a great purchase at a severely discounted price, whereas the best real estate location in the world may make a bad purchase if the buyer pays too much. The right type of asset, in the context of NNN properties, simply takes into account the ability to place other tenants in the space, if need be. A property fully customized to one particular tenant can be very difficult to fill in the event that the original tenant defaults or does not renew their lease.
3) Tenant: Who is the right tenant? In this particularly volatile economy, for those looking for stable income, we recommend assets with strong, national tenants with little to no debt or with a credit rating that is at or above investment grade (a credit rating BBB- or better). When looking for the right tenant, an investor must distinguish between corporate-backed and franchise-backed leases. The strength of a particular brand or chain of stores may indicate the popularity of their product or service, but it may not indicate the strength of a lease if the parent corporation is not liable for the payments. The difference between the strength and staying power of an individual franchisee and a large, national corporation could be significant.
It is also essential for an investor to consider tenants protected or benefiting from a more difficult or volatile economy. Tenants that provide irreplaceable or discounted consumer necessities are typically better positioned to weather difficult times. The NNN property market is diverse and provides a broad array of tenant options for a client to customize their investment portfolio.
4) Lease: Information pertaining to selecting the right lease is provided in greater detail in the article "Analyzing Lease Terms," which should be included in your packet. If you have received this article independent of the packet, please let us know and we will forward you the additional articles. In summary, the right lease requires a lease term long enough to provide stability, set with regular, contractually obligated increases in the rent ("lease bumps"), and free from unfair early termination clauses and renewal options.
5) Ownership Structure: With regard to ownership structure, please read "Real Estate Ownership Types" (and feel free to let us know if you need a copy). We recommend fee simple ownership as well as leased fee ownership. The investor should own the land and the improvements or just the land itself, rather than owning only the improvements on a ground lease (leasehold interest ownership).
As you search for investment solutions through NNN property, keep these five aspects of NNN investments in mind. A tremendous number of bad investments are out there--and many of them may appear fairly attractive. While all real estate purchases involve trade-offs, being equipped to know what to look for has helped us filter out the poorer-quality investments so that we are able to recommend suitable investment selections to meet our clients' needs.