There are five major aspects of a triple net property that one should investigate prior to investing. If a property performs well in all five of these respects, it is more likely to be able to provide reliable income and has more potential for long-term appreciation.
Investors in triple net property should look for:
- The Right Ownership Structure
- The Right Lease
- The Right Location
- The Right Tenants
- The Right Value
The Right Ownership Structure
There are several different real estate ownership structures available to investors. The bottom line is that fee simple ownership is the best, and leased fee ownership is a decent second. Investors should own both the land and the improvements, or else the just the land. Merely owning the improvements and not the land, a structure known as a leasehold interest, has a major disadvantage: ownership of the improvements is automatically reassigned to the landowner when the ground lease expires. If an investor considers this a deal breaker, it should be examined first as a means of screening investment offerings.
The Right Lease
The appeal of triple net properties is that their leases place all responsibilities on the tenants, providing investors with stable, passive income. However the specific terms laid out in an NNN lease contract make all the difference. The term length of the lease is one of the most important factors. Lease length should be long enough to provide a tenant with a stable location that is attractive, and the ability to last a full market cycle. The length of a market cycle varies, but in general 10 years is a good rule of thumb. If there is a downturn during the lease, 10 years will give the market enough time to recover so you are not trying to re-tenant during a recession. Another important factor is extension options and rent escalations that are tied into the lease. These will increase the possibility that your tenant is willing to stay in your property as well as increase the rent you will receive from them.
The Right Location
Real estate is all about location. This holds true in NNN real estate. A strong location offers the ability to re-tenant the property should anything happen to the original tenant in the investment. Some investors may use the strength of a tenant to off-set a weak location. While it may turn out positively, mitigating the risk of tenant loss by choosing a strong location is a better investment choice. In general the cost of a great location will be higher, but it provides downside protection and the added bonus of potential value increase when you go to sell the property.
The Right Tenants
Finding the right tenant to occupy an investment space is paramount to the success of the investment. In general for NNN lease properties, a good choice is a nationally recognized tenant with little to no debt, or with an investment grade credit rating from one of the three major credit rating agencies. A rating of BBB- or better would be considered investment grade. In addition to this, investors should look for a lease that is guaranteed by the parent corporation. For example, Omnicare is a Pharmacy brand that is a subsidiary of CVS Health. Omnicare may be a good tenant in its own right, but with a lease guaranteed and backed by CVS Health an investor should feel much more comfortable.
In addition to this, a company that remains strong in a recession is another way to mitigate risk. Again using CVS as an example, should a recession hit the United States, most people may save some cash by skipping their Starbucks Coffee, but most will not try to save money by not refilling their prescriptions. A rule of thumb is to look for a tenant that provides a discount or necessity product that is positioned to survive a market downturn.
The Right Value
The asset value includes the condition and price of the asset. These factors must be weighed in conjunction with each other. An asset that is in poor condition may be a great asset for the right price, and an asset in prime condition may not be a great investment if the cost is too high. In terms of a NNN property, the ability to house different types of tenants is important. If a property is in prime condition, but is custom designed as a medical office, it would be hard to re-tenant the space unless you find another medical office tenant or spend capital to refigure the space for a different tenant. It is important to weigh these factors against each other when analyzing a property to get a feel for the ability for the asset to perform.