The major advantage of investing in a net lease property over traditional investments like bonds and stocks will be discussed in this article. We’ll start with a definition of net lease and then move on to traditional investment in its own section. We shall also be discussing how to triple net lease for sale.
We may assess dozens of commercial properties as potential acquisition possibilities in a given month or year. We consider essential physical characteristics like as location and condition, but we also spend time evaluating aspects that aren’t visible. The leases for the property’s existing tenants are one of these things.
Understanding the structure, monthly payments, expiration dates, and lease type for each lease, among other things, is essential for preparing a financial projection for the property and predicting prospective returns. For commercial buildings, there are two sorts of leases, and knowing the difference is crucial to the accuracy of the prediction. In this post, we’ll go through the differences between a gross and a net lease before diving deeper into net leases in real estate compared to bonds on the other hand.
What is Net Lease, and how does it work?
In a net lease, the tenant pays a base rate plus a portion of the property’s operational expenses, which is usually proportional to the percentage of space they lease in the property. As a result, the base rental payment is typically cheaper because the property owner is aware that the tenant is covering their share of operating costs. Net leases come in a variety of forms in real estate, but they’re most popular in office, industrial, and retail buildings.
There are four different types of net leases.
- Single Net Lease: In a Single Net Lease, the tenant is responsible for both the base rent and the property taxes.
- Double Net Lease: The tenant pays their base rent plus property taxes and insurance in a “Double” net lease. • Triple Net Lease: Also known as a NNN lease, the Triple Net Lease is the most prevalent type of net lease. The tenant pays a base rental rate plus property taxes, insurance, and maintenance in this structure.
- Absolute Triple Net Lease / Bonded Lease: The tenant pays a base rent plus all operating expenses in an absolute net lease.
Because of the one-of-a-kind nature of the Net lease structure, there are a number of advantages and hazards to be aware of.
Traditional Bonds as a Speculative Investment These are typical investments in the sense that you put your money down and hold it for a long time. These assets can bring stability to more aggressive — and riskier — investment methods, even if you wish to make changes as needed to preserve your investment (like trading and hedging).
Governments, government agencies, municipalities, and corporations all have the option of selling bonds to obtain funds. When you buy a bond, you’re essentially giving money to a company in exchange for the promise of repayment and a certain annual return. A bond is just an IOU with a serial number in this sense. Bonds are referred to as debt securities or fixed-income securities by some people to seem more impressive.
Stocks and bonds are among the many investment options available to you as an investor. The investment you choose is determined by your financial objectives, investment choices, and risk tolerance.
Bonds, while some are more reliable than others, offer a level of consistency and predictability that is unmatched by most other assets. Bonds are more conservative investments than stocks, commodities, or collectibles because they provide a consistent stream of income (annual returns, for example) and because you anticipate to get your principle back in one piece (at the end of the bond’s life). Investing in net lease, on the other hand, outperforms them all.
It not only makes more money, but it also saves time and money.
There are a variety of perks and hazards to be aware of because of the uniqueness of the Net lease arrangement.
Net Lease Benefits and Risks
The tenant is the most significant advantage of the net lease real estate system (s). Walmart, McDonalds, and CVS are examples of well-known firms having a robust balance sheet. As a result, there is a lot of faith that the lease payments will be made on time each month. However, that isn’t the only advantage you can triple net properties for sale. Other options include:
- Property Management: In a NNN property, the owner’s responsibility of property maintenance is reduced because the tenant is liable for it.
- Rent Increases at Regular Intervals: Many Net leases include “escalators” that provide for periodic increases in the rental rate at various intervals throughout the lease term. Over time, these escalators boost a property’s Net Operating Income (and value). They also assist the returns keep up with, or outperform, inflation.
- Lease Term: Tenants of net lease real estate typically sign long-term leases that can last up to 25 years. As a result, they generate a long-term cash flow stream for investors. It’s also vital to remember that the lease’s remaining term at the time of purchase has a direct impact on the property’s asking price. The less time left, the higher the risk and the lower the cost. • Operating Expenses: In a Net lease real estate arrangement, the tenant is responsible for the property’s operating expenses, therefore the risk of those expenses rising is held by the tenant, not the property owner.
- Favorable Financing Terms: Because net leased real estate properties typically have long-term leases and strong tenants, lenders are more willing to give favorable debt terms.
However, like with any investment, there are dangers associated with net lease real estate, but the benefit outweighs the risk when compared to typical investments.
- Cost: Credit tenants with a strong credit rating, such as Walmart or Walgreens, and the steadiness that comes with them, can be costly. Because of the hefty upfront expenditure, future upside may be limited as the property becomes more of a cash flow play with less potential for capital appreciation.
- Concentration of Tenants: Single-tenant buildings are either 100 percent occupied or 0 percent occupied with no cash flow if the tenant quits. Because retail spaces are generally custom-built for their tenants, repurposing the space for a new tenant can take months – and thousands of dollars.
Investment Strategies for Net Leases
When we evaluate a net lease real estate investment opportunity, we categorize it into one of two categories: Value Add or Core.
The Core bucket is simple to understand. There are deals with long-term leases, good tenants, consistent cash flows, and rent escalations on a regular basis. As a result, they are generally low-risk. We enjoy core bargains, but we aren’t always willing to pay core rates. We are frequently able to negotiate cap rate discounts of 50 or 100 basis points since we have large, long-standing contacts in the brokerage industry and they know we can close a deal.
The other category is “value add,” which includes agreements that are less clear and may have a higher risk/reward ratio. Frequently, they involve a motivated seller wanting to sell the property because the tenant’s lease is up for renewal. In situations like these, we can use our existing contacts and operational knowledge to buy the property at a lower price than its inherent value and then renegotiate or renew the lease to add significant, immediate value.
Returns on Net Leases
Returns on net-leased properties are lower than other investment kinds due to their stability. However, positioning the property as a turnkey investment so that a core buyer can come in and pay full market price is one of the tactics we utilize to optimize return possibilities.
The actual rate of return for a net leased property is determined by two essential lease elements: the number of years left on the lease and the amount of rent that will climb during the remaining time. We actively seek to maximize both in order to position the property for a key buyer. For example, in exchange for a lease extension, we may offer the tenant cash for building renovations or a flat rent or reduced rental rise in exchange for a new, long-term lease. In either case, the goal is to put the property in the best possible position to sell for the most money.
Conclusion and Summary
Net leased properties are a popular choice for investors seeking consistent cash flow and minimal involvement in day-to-day property management. However, this does not imply that investing in them is “simple.” However, as I previously stated, it is more profitable and long-term than standard investments such as bonds. Buyers must spend significant time up front evaluating the purchase from all sides to verify that it fits their risk tolerance and time horizon. The following are some of the best practices:
- Examine the tenant’s financial situation: does he or she have good credit and a strong balance sheet?
- Examine the real estate fundamentals: Is the property in a strong market with large traffic counts and good visibility from the road?
- Examine the lease term: How many years does the lease have left, and what can be done to extend it?
- Look for rental escalations: To ensure that returns keep up with inflation, leases should include periodic rent escalations.
- Avoid unreplaceable high rents: If a tenant leaves, you’ll want to be able to replace them at a rental cost that’s the same as or greater than the previous one.
Unless there is a large length of time left on the lease, properties with high rents relative to the market should be avoided.
- Consider stability in comparison to other asset classes: Compare the property’s cash flow stability to that of other income-producing assets, such as bonds, to ensure that the return is appropriate with the risk.
Net leased properties can be a profitable addition to any real estate investment portfolio with the right amount of due diligence and proactive risk mitigation methods.