Explaining Single Tenant Triple-Net (NNN) Properties - The Popular 1031 Exchange Option
What is it?
These types of properties have only one tenant and are commonly free-standing buildings. This can be any type of tenant, big or small, but for almost all of our 1031 exchange clients, we will be looking at large corporation tenants like McDonalds, Walmart, Walgreens, Dollar General, 7-Eleven, Starbucks, etc..
What does triple-net mean?
Triple-net is a type of lease that is extremely common in these types of buildings. These leases state that ALL expenses and management duties fall on the responsibility of the TENANT, not the landlord. This means that the tenant will pay for everything and manage everything. This includes but is not limited to: roof and structure maintenance, insurance payments, property taxes, added insurance like earthquake and extreme weather insurance, any other maintenance of the property, etc.
The only expense that you would ever have on a triple-net property would be loan payments, if you decide to get a loan.
Literally, if the building burns down or is blown over by a hurricane, the tenant will be responsible to rebuild.
Types of guarantees on the leases:
Each one of these leases will be guaranteed by something or some entity. This can range from a single individual, to a franchisee with a few or many locations, or lastly it can be guaranteed by the entire corporation.
In most circumstances, it is recommended to find a lease guaranteed by the entire corporation. This makes it so the only risk of not collecting rent will be if the entire corporation declares for bankruptcy. In other words, if you bought a Taco Bell, and for some reason that tenant moves out of your location, Taco Bell corporation would be legally obligated to pay you rent for the remainder of the lease; even if they are not occupying the space anymore.
Sometimes it can still make sense to invest in a property that is guaranteed by a franchisee. This would only make sense if the franchisee owned many locations (10+), and that individual franchisee had very solid personal finances. Usually franchisee guarantees give you better returns.
Remember, the stronger the guarantee is on the lease, the lower the return with be (risk vs. reward).
Why are triple-net properties the most common 1031 exchange option for apartment owners?
The absolute most popular reason is simple: MORE CASH FLOW and ZERO MANAGEMENT
Since these buildings have inherently higher CAP rates (higher rates of return) than apartment buildings, in almost all cases, you will make more money each month by trading out of apartments and into NNN properties with the same amount of equity. In many cases, our clients’ cash flow can double, triple, or more!
An added benefit to trading into NNN would be the potential for a new depreciation schedule. In many cases, apartment building owners have owned their buildings for so long that they have run out of deprecation or are close to the end of the depreciation life. Therefore, with an exchange into NNN, you would not only increase your cash flow, but you could also decrease your tax payments!
Going out of state:
Since these types of properties are everywhere and in every city throughout the nation, it is very common that the correct property for your exchange will be out of California.
• Yes, going out of state can be nerve-wracking since it is something that you are not used to. Luckily, Marcus & Millichap is the largest commercial sales company in the nation and we have the research to back it up.
• With every investment opportunity, you will be given the following:
> Demographic report and expected population growth (we want to know there are enough people living in a particular area to keep your tenant in business)
> Median Household Income (it is always best to go into markets where the median income is the highest)
> Traffic counts (you want a very high traffic count on the street that your building is located)
> National tenants nearby (you want your property to be on a dense retail corridor that has other national tenants on the same block or close by; this proves that the location is desirable)
• If an investment opportunity shows good numbers on the preceding 4 investment criteria, you can be very comfortable that your tenant will stay in business and thrive. If for some reason that tenant moves out, you will then be comfortable that you will be able to re- tenant the building due to the good underlying essentials of good real estate… Location, Location, Location.
The “Amazon Effect” or “Internet Effect”:
Yes, the world is ever-changing and we have seen many examples of huge companies going bankrupt due to this change to the internet, but physical retail will never go away. You will simply need to be smart when picking the best tenant type to invest in.
When we are looking for the best property for you, we will be looking at tenants that we feel are “internet proof”. In other words, tenants that will always need a physical presence.
Here are some examples:
• Fast foods – these are never going away in America. Also, fast foods thrive in recessions.
• Medical places –Dialysis Centers and Drug Stores will also have to have a physical presence
> Popular Examples: Walgreens, CVS, DaVita Dialysis
• Car Mechanics – people will always have to physically bring their cars in for service
> Popular Example: Caliber Collision
• Gas Stations – As long as there are cars, there will be gas stations.
• Sit down restaurants – while these are not as safe as fast food, restaurants will always be around. You just need to familiarize yourself with the particular restaurant you want to invest in to make sure that is a store that is there for the long run
> Popular Examples: Bojangles, Red Lobster, IHOP, Arby’s, Buffalo Wild Wings, Chili’s, etc.
• Convenience Stores – these discount stores will always be around and thrive in recessions
> Popular Examples: 7-Eleven, Dollar General, Dollar Tree, 99 cent stores, etc.
The lease is not long enough:
Yes, it is true that some sellers of these NNN properties are selling when the lease is near the end of the term. When picking your best property, we will avoid these types of listings.
Luckily, you are dealing with the #1 commercial broker in the nation, Marcus & Millichap. Since we have more inventory than all of our competitors, we can be sure to match you up with a property that has a lease of a minimum of 10 years remaining, but preferably 15 to 20 years remaining on the guaranteed lease.
Our favorite two types of investments would be… 1) Brand new construction with brand new 15- or 20-year lease, or 2) Tenant that just renewed a 15- or 20-year lease after long operating history at that location.