A few years ago, only a few people knew about triple net (NNN) properties. However, recently there’s been so much about NNN properties in the media. Are you wondering what triple net properties are, how they work, and the terms and conditions of the contracts? Worry no more. Here’s an overview of NNN properties and what you should know before investing in triple net properties.
What are triple properties?
A triple net lease is a commercial property contract where the tenant covers the property’s taxes, maintenance fees, and building fees on top of the monthly rent. Different triple net properties have unique considerations and parameters.
Before investing in triple net properties, you have to conduct an assessment of the contract. Here are some of the essential factors to consider.
Tenant quality
Tenant quality is the expected reliability and conduct of the occupant. The most preferred tenants are low-risk tenants since most NNN tenants are single-tenant based. As an investor, you don’t want to risk your investment if a tenant is declared bankrupt. On the other hand, high-risk tenants will bring more returns on investment. The choice tenant depends on the investor’s risk tolerance.
Unit economics
Unit economics helps to identify revenue and costs attributed to the business within the rented property. A proper unit economics evaluation will help you estimate the expected profits and the likelihood of a lease renewal. The operational expectations and the tenant quality will influence the unit economics.
For example, a mattress company has varying operational expectations from a Starbucks. The two tenants may negotiate different lease structures. The unit economics also comes in handy in the comparisons between other properties within the exact location.
Co-tenancy
A co-tenancy is a particular clause that specifies conditions for the neighbouring businesses. This provision will offer your tenants protection against unfair competition next door. The clause is also necessary to avoid situations of downtimes when anchoring business next door relocates. The two circumstances can result in a change in customer traffic, and a company conscious about its competition may deliberate for this provision as a precaution.
Rent and lease duration
Long-term NNN leases offer the tenant longevity and stability. However, you must be keen on rent increment to cover for inflation. Failing to account for inflation can affect your profit margins or entirely offset them depending on the lease duration.
Besides, you can include options for renewal that mutually offer you and the tenant a solution to a long-term contract. Triple net leases with options for renewal are the most sought-after for unproven business models.
Early termination
This clause offers tenants to end the contract before the lease duration lapses. However, the provision results in a significant loss of cash flow. The tenant has to give prior notice with a lump-sum payment for the early termination. Suppose you’re in a 10-year lease agreement that allows the tenant to end the contract once at the end of 5 years. If you want to invest a purchase an asset with a ten-year lease, you need to underwrite it as a five-year lease.
Some leases by the government give the tenants a right to end the contract if the said governmental agency loses funding that year.
The credit rating of the tenant
Not all tenants are equal. Some corporates are renowned brands but have a negative credit rating. Some tenants operate a franchise model without significant capitalization. It’s essential to be comfortable with your tenant’s business model and credit score before investing on the triple net property.
Price per square foot
The price per foot of the property is driven by the rate paid and the size of the property. You should also consider the prices set by similar properties in the same jurisdiction. This consideration can leave an investor vulnerable if the tenant becomes files for bankruptcy or vacates.
Re-use adaptability of the building
Some properties are easier to convert for alternative uses. Fast food stores, auto parts, and general shops are examples of buildings that can be easily converted for other services. Some specialty buildings can become very expensive to convert. For example, banks with vaults, some restaurants in multilevel facilities, or medical clinics require a lot of resources for re-purposing.
Debt on the property
There are assets in the market with long-term debt that can’t be paid off early without penalties. Most of the debts come from commercial mortgage-backed security or a life insurance company. In both cases, the penalty, commonly referred to as defeasance, is stiff.
In this case, investors should evaluate the terms of the debt and assumption fees to evaluate whether the property meets the acquisition requirements.
Final words
You need to consider the metrics mentioned above before investing in triple net properties. Some people like investing in small markets, while others are fond of short-term commitments. Whichever you pick, check what’s in the market before you start investing.
