By Christopher Miller, MBA
What are net leased properties
Net leased properties get their name from the way expenses are handled; rent is paid to the “net” lessor (lessee pays) certain expenses. In any type of net lease, the tenant will typically pay all operating expenses, such as electricity, gas, and water. Property taxes and insurance are also the responsibility of the tenant in a “double net” or NN lease. A “triple net” lease, or NNN, will transfer all responsibilities and expenses to the tenant – even building maintenance. The net leased properties that I come across – with long-term leases and tenants on credit – will typically have double net or triple net leases, so that’s what this article will focus on.
Why NN rather than NNN?
You may ask “Why buy an NN rented property when the NNN one means I have less responsibility?” The answer is “it may make more financial sense”. With a gross commercial lease, the landlord pays for all expenses – even electricity. For this reason, the rent is higher; since that money has to come from somewhere, after all. If a tenant accepts an NN lease, they get a large “discount” on their rent, while an NNN tenant pays even less. An investor buying properties must weigh income, location, rental terms, tenant strength and many other variables to find their best acquisition target.
What I am looking for in rental properties on the Internet
As I mentioned above, there are many factors you should consider before buying a property. There isn’t just one very important thing to look for; there are many. Some things I always like to look for in rented properties are:
Good leases with rising rents
I have proclaimed this fact many times in numerous articles over the years: Rising rents lead to rising property values. Since investors buy properties based on their income generating potential, they will pay more for a property that earns a higher rate of income. Just as you increase the value of your apartment by increasing your rents, so do business owners.
Some triple net leased buildings have flat rate leases – and 50 years (or more) of options that could guarantee the same low rent until the 2080s! It is not a good property to buy. (I would say “obviously”, but someone is buying them.) A 10 or even 20 year flat rate lease may be acceptable if you can increase the rents when the lease expires – and if you are comfortable with a lease. longer holding period with apartment income. Any longer than that, and the value of your property could be locked in at the same rate for decades. Also remember that inflation will eat away at the purchasing power of this rent over a long period of time so your income doesn’t just stay the same – it slowly goes down.
A business can be engaged in a building under a lease of 10 years or more, but a landlord must ensure that the tenant can stay in business for that long. I prefer to look for strong credit tenants with a national presence – many stores in many states. I want to see a company that is growing in turnover, employees and number of sites and I want to choose a tenant in an industry that I am optimistic about
Pay attention to renewal options
Almost two years ago, I wrote an article titled “When buying real estate, this ‘positive’ characteristic could be negative.” The first paragraph dealt with lease renewal options and why they a bad thing for owners. This is because a lease renewal option works the same way as a purchase option for a share. If market rents go up, the owner of that option (in this case the tenant) benefits by renting space below the market rate. So – if he pays $ 10 spf now and the market rent is $ 14 psf; but he has an option of $ 11, he will exercise his option to renew his lease at that lower rate. If the market rents drop to $ 9, rather than exercising that $ 11 option, he will simply negotiate with you to re-let it at the lower rate. So the option is really a upper limit on what the tenant will pay in the future – this is only valid for the tenant. It is acceptable to include options in a new lease or to buy a property with options; just make sure the options contain sufficient rent increases. That way, if the tenant stays put and exercises those options, you can still get your rent increases.
As with any real estate transaction, you can hope for the best, but you should expect the worst. I prefer net rented properties in large metropolitan areas. I’ve seen properties listed where 3,000 people live within a 10 mile radius and have an average income of $ 18,000 per year. If the current tenant is in financial difficulty, or even just leaves at the end of the lease, it’s hard to imagine that many other tenants have an interest in such a property. I have talked a lot recently about the ever increasing population of the United States. Between the 2010 census and today, it is estimated that our country added 2.6 million inhabitants per year. This means that we have to build the Chicago equivalent (the 3rd largest city in the United States) across our country every year. I prefer to buy property in growing cities where more of these new residents are moving.
Net leased properties can be a good way to seek predictable income from your next investment property. If you have any questions about them, I would be happy to discuss them with you. The toll-free number for my Tustin office is 877-313-1868.
Christopher Miller is Managing Director of Specialized Wealth Management and specializes in tax-advantaged investments, including 1,031 replacement properties. Chris’ real estate experience includes work in business valuation, institutional acquisitions for a national real estate syndicator and as an advisor helping clients through more than four hundred 1031 exchanges. Chris has been featured as an expert in several industry and television publications and earned an undergraduate degree in commerce and an MBA with a focus in real estate finance from the University of Southern California. Chris started his career in real estate in 1998. Call him toll free at (877) 313 – 1868.
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