Real Estate - FEBRUARY 17, 2015

Nothing but net

by Sheila Hopkins

It’s no surprise that triple-net (NNN) lease investments are riding a wave of popularity. Who wouldn’t be attracted to an investment that boasts little to no management responsibilities, stable long-term cash flows, attractive financing and the tax benefits of real estate? As with all real estate investments, however, buyers need to know what they are getting into before jumping — danger can lurk below the most inviting waters.

NNN lease investments get their name from the lease structure, which requires the tenant to pay all expenses, including real estate taxes, maintenance and insurance (thus “net, net, net”), as well as rent, utilities and other standard fees.

These investments are typically new single-tenant, freestanding buildings with very long-term, non-cancellable leases, usually covering 10 to 25 years plus extension options. This means owners don’t need to worry about vacancies, tenant turnover or improvement costs. Although most investors think of NNN investments in terms of retail assets (gas station, drug store, fast food, etc.), they can be structured for a variety of industries, including specialty office, medical, industrial and warehouse.

NNN investments offer strong, predictable cash flows at yields often above 5 percent, which looks pretty good to investors in today’s low-interest environment. Banks love predictable returns, and thus investors have access to attractive debt financing. In addition, there is often the chance to add value to the property during acquisition. This is still a very fragmented and inefficient market, and investors can often negotiate price and financing terms in their favor.

Investors who prefer to and are able to own assets directly will find a supply of properties on offer at nearly any large brokerage. These brokerages typically have personnel who are trained to work with clients’ accountants, lawyers and financing options to obtain the desired results, as well as divisions that can take on property management if needed. For those who want a diversified portfolio but can’t afford to buy several properties directly, or want a more passive investment, firms such as Broadstone Real Estate offer private REIT vehicles that hold large portfolios NNN properties diversified across industry and geography. This type of diversification mitigates the investment’s primary risk — that the tenant will fail and the investor will be left with an empty building.

All real estate investments carry risk, and NNN investments are no different. Location is crucial, as always, in real estate. Tenant credit is crucial, as is the future market for the tenant’s business. Investors should look ahead 10 to 20 years. Does the tenant have a business that will survive that long? Specialized buildings, such as those used for fast-food franchises, can be difficult to adapt to other uses. And, as many investors are finding a safe haven in NNN investments, prices are going up. These are typically one-off deals and thus hard to value, but in these situations, investors need to curb their enthusiasm to make sure they don’t overpay.

NNN properties are rightly finding their way into investment portfolios. The benefits are obvious and the risks can be mitigated. But investors still need to exercise care. Nothing is perfect, even NNN investments. But many investors think they are pretty close.

To find out more about NNN investments, check out IREI’s Triple-Net Investor Strategies conference on June 16 in New York City.

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