MJF008 What Is a Single-Tenant Triple-Net Lease Property?

by Michael Flight

07.03.2018

A picture of the Mirage Resort and Casino in Las Vegas Nevada USA along with the famous volcano on a sunny morning. The Mirage is owned by a REIT as a net lease property. Photo credit Michael Flight all rights reserved.

What Is a Single-Tenant Triple-Net Lease Property?

This article was originally published on www.concordiarealty.com on July 3, 2018.

Net-Lease Single-Tenant (NLST) real estate investments are one of the faster growing sectors of the entire real estate market.  Investors want the benefits of a hassle free “armchair” investment and tenants like the flexibility and financial benefits created by entering in to these agreements.  With a Net-Lease Single-Tenant Retail property an investor typically is acquiring a property with a corporate lease (backed by a larger company with income sources spread out over a number of stores), a stable, long-term investment with limited management responsibilities for the property owner,and income growth through periodic increases.

Net-Lease Single-Tenant real estate is attractive to investors in that the leases are structured Triple Net lease (or “NNN” lease) so that the investment is less management intensive, it provides a more stable income and fewer direct costs to the property owner.  Many Net-Lease Single-Tenant investors are experienced multifamily and shopping center owners trading into lease property management hassles through 1031 Exchanges.  As these investors become less hands-on and scale back towards retirement they find Net-Lease Single-Tenant properties can provide them with cash flow, relatively passive income and capital appreciation while still taking advantage of positive leverage that real estate investments provide.  Many real estate investors nearing retirement utilize Net-Lease Single-Tenant properties as an estate planning tool to uncomplicate their portfolio for heirs that may not be interested or capable of day to day property management.

The three (3) most important factors in successful Net-Lease Single-Tenant investing are:  Great Location, Credit Quality (corporate guarantee) and tenant Brand name.

Single-Tenant Net-Lease property investment has many of the characteristics of buying a bond.  The Investment Grade (IG) rating from Moody’s, Standard & Poor and Fitch are an important factor to consider along with the location aspects and condition of the property. Net-Leased Single-Tenant Retail properties have become highly sought after by individual investors, REITs, insurance companies, pension funds and other institutional investors.  These larger, more sophisticated investors seek to invest in “Investment Grade” property assets which are tenants with credit ratings at least BBB- or higher by Fitch and Standard & Poor or Baa3 or higher by Moody’s.  Many Net-Lease Single-Tenant Triple Net Retail properties are leased to publicly traded companies such as CVS, Walgreens, Autozone, 7-11; Dollar General, McDonald’s, Chick-Fil-A, Starbucks, Walmart, Whole Foods, Hobby Lobby or Kroger. In this case it’s easy to pull up investment research from reputable online stock analysis sources or a good site for the number of stores in a chain, sales growth trends and same store sales is: https://retail-index.emarketer.com .

Net-Lease Single-Tenant property is probably the most passive type of direct real estate investment you will find outside of investing in a REIT, syndication or CrowdFunding platform.  The reason is that you are dealing with one tenant who is very interested in making the rent payment every month on time to maintain that credit rating (in many cases the tenants prefer to make ACH transfers directly to your bank account) AND with a Triple Net lease the tenant pays taxes, insurance and maintains a high percentage of the property.

The main drawback to Net-Lease Single-Tenant retail real estate investments is that you are reliant on one (1) tenant for the sole source of your income.  So credit quality is VERY important to the success of your investment. However, many NLST investors overlook or under appreciate the factor that LOCATION quality plays in the success or continued occupancy (and continued income stream) by the tenant.  So while many sources will explain to you how to underwrite credit risk and the fact that only a small percentage of investment grade tenants go into bankruptcy or liquidation they don’t seem to stress enough the how to underwrite location quality.

Many of the same factors that make a successful shopping center also apply to a Net-Lease Single-Tenant retail investment.  Is the store doing adequate to above average sales for the chain and how does it compare to industry averages?  Additionally, you have a much higher likelihood of a tenant being in the same location if the property is located at or near the nexus of retail activity within the Trade Area.  Is it easy to get in and out of the property?  Retailer store sizes and prototypes periodically change to fit new developments with serving their customers better.  You need to make sure the property you are buying conforms with a store layout that is the current prototype for that tenant or has design flexibility if the prototype changes.    Which leads to another important factor, how specialized is the building to the use? A general purpose retail building like that built for a Dollar store or Drugstore will be easier to convert to another use at the expiration or early termination of the lease.  Fast food restaurants, bank buildings and movie theaters are special purpose buildings that are much more difficult to repurpose. Sometimes the rent is artificially higher because the developer has amortised the costs of Tenant Improvements over the initial term of the lease.

The credit worthiness of a tenant typically is reflected in the pricing of a  Net-Lease Single-Tenant retail investment, the higher the credit rating typically the lower the cap rate, or return on your investment. Mergers or private equity buyouts can also affect the stability of a company.  In the case of a merger, it might make the combined company stronger or may be a larger company buying a fast growing smaller company to further roll out an expansion. However, many mergers are two ailing companies joining together in hopes of holding each other up.  A good example would be the merger of Sears and Kmart which has failed to halt the steady decline for both brands. Another concern would be private equity taking a publicly traded brand private, loading it up with debt and stripping the assets.  There is not necessarily anything wrong with this investment strategy but it could be negative for a property owner if rapid expansion is used to artificially pump up sales and ends up cannibalizing the sales at good locations.  Additionally, these situations can be very good if the investment is made in operations and merchandising and not fees for the private equity group.

Brand Name is also a major factor in the pricing and likelihood of the tenant occupying and paying rent throughout the term of the lease.  A great brand name paying the rent and maintaining your building will make your property more valuable because of the advertising/marketing the do to make their brand stand out. For example McDonald’s, for all the grief that consumer advocates and public health officials dish out regarding the home of the Big Mac, you know that when you go into any of their restaurants the experience is going to be uniformly consistent because of the systems they have put in place. Or when thinking about going “out” for coffee or in certain peoples minds anytime thinking about coffee, Starbucks immediately is first and foremost in the public’s perception. The same factors will contribute to the tenant occupying and paying rent.  The more sales, the more the tenant can afford to pay. This can also cut in the opposite direction should something happen to tarnish the Brand Name which ends up diminishing the value or the cap rate on your Net Lease Single Tenant investment when the time comes for disposition. Some brands fall out of favor or are run into the ground and then go into bankruptcy.

There is also a difference between a Net-Lease Single-Tenant Ground Lease versus a net-lease single tenant occupying a building that the investor owns. With a Net-Lease Single-Tenant Ground Lease, you as the investor get a completely hands off, no expenses or surprises real estate investment. These types of properties are often advertised or listed as Absolute NNN , Absolute Triple Net or True Triple Net Lease because the tenant pays rent for the land and then the tenant is responsible for all expenses related to any of the building or improvements in addition to real estate taxes, insurance and utilities.  Additionally, depending on the credit of the tenant they also might be advertised as a “Bond Lease” or my favorite legal term of art “Hell-or-High-Water Lease” where the tenant is responsible for everything.  In essence, the “Not My Problem – Just Pay the Rent – Thank You Very Much” lease.

The biggest risk with any Net-Lease Single-Tenant property is that at the end of the day you the investor are dependant on one tenant for all the income unlike shopping centers or multifamily properties where the risks are mitigated by multiple rent payers.  Net-Lease Single-Tenant properties are either 100% occupied and paying rent or 100% vacant and costing you money.  If the tenant vacates at the end of their term you have a building or property that needs to be re-leased or sold.  The value of the building was based on the income stream so now it will in many cases be much less than the original investment.  Additionally, unlike investing in a the securities known as a Bond, where if the company stops paying all you have is a worthless piece of paper.  With a vacant building, you the investor have a real liability to pay property taxes, maintain insurance and secure the property from vandalism and theft.  Re-leasing and re-tenanting the building will probably require capital expenditures in the form of commissions, architectural plans, building permits and tenant improvements. Many Net-Lease Single-Tenant properties are listed for sale a few years before the expiration of the term with the tenant having an Option to Renew.  The Option is is completely in the tenant’s favor and one of three things can happen:  1.) the tenant renews its option; 2.) the tenant does not renew its option and vacates the property; 3.) the tenant does not renew its option or threatens not to renew and renegotiates a lower rental rate.  There is also a fourth circumstance which may work out in your favor which is that the tenant misses the option exercise date in a fantastic location and you get to increase the rent. This is very rare and carries some risk in pulling it off successfully.

To reiterate, the three (3) most important factors in successful Net-Lease Single-Tenant investing are:  Great Location, Credit Quality (corporate guarantee) and tenant Brand Name.

The Single-Tenant Net-Lease sector of the Real Estate Investment market is a popular option for investors looking to get into Retail Real Estate Investment.   The attractiveness of long term leases to stable tenants with minimal to no management hassles make the sector a popular bet for a variety of commercial real estate investors.  I expect Net-Lease Single-Tenant Retail Real Estate to remain strong and even continue to grow with new tenants and concepts coming into the market.

Michael J. Flight

Principal at Concordia Realty Corporation
CEO & Co-Founder of Liberty Real Estate Fund
Co-Founder & Chief Strategy Officer of Invest On Main
Co-Founder of Blockchain Real Estate Summit

Michael J Flight was named the Godfather of Blockchain Real Estate by Forbes Crypto Editor Dustin Plantholdt. Michael achieved that distinction by co-founding Liberty Real Estate Fund, the World’s First Net Lease Security Token FundTM and creating the Blockchain Real Estate SummitTM. More recently, Michael has co-founded Invest On Main (IOM.ai) the Real Estate & Alternative Asset marketplace of the future and AcceleratedLaw a faster, more affordable way to create and tokenize securities offerings!

Michael is a real estate entrepreneur and real estate tokenization pioneer who is an expert in retail real estate investment, redevelopment and real estate on the blockchain. He started his commercial real estate career in 1985, and then co-founded Concordia Realty Corporation in 1990, which continues to partner with some of the world’s most well-known banks, insurance companies, hedge funds and institutional investors in many successful investments.

Michael is a real estate entrepreneur and Blockchain Real Estate evangelist who is an expert in retail real estate (Shopping Centers and Single-Tenant Net-Leased) investment, redevelopment and real estate on the blockchain. He has an extensive record of value-add shopping center redevelopment and with partners Merchant Equity Group, LLC as a pioneer in de-malling (repurposing enclosed malls). Michael has been active in commercial real estate over the past 35 years.

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