Why Net Lease Real Estate Is a Safe Investing Alternative in Tough Times
- May 08, 2020
Net lease real estate is a significant part of the industry and triple net leases—also known as net-net-net leases (NNN)—are the most common. What is the difference between net and triple net lease? In an NNN lease agreement, all the costs related to the property— including taxes, insurance fees and maintenance—plus the rent are the tenant’s responsibility compared to the single net lease agreement in which the tenant agrees to only pay property taxes in addition to rent. Additionally, triple net lease real estate agreements are typical for buildings with a single tenant and are usually long-term.
In these difficult economic times, net lease properties are one of the most popular investing alternatives because they provide a steady cash flow with an annual rent increase.
In the interview below, Camille Renshaw, CEO of Brokers+Engineers (B+E), discusses why net lease is a safer investing alternative during downturns, the challenges of net lease investment and the most in-demand properties mid-pandemic.
Can net lease be considered a safer investing alternative in turbulent times?
Renshaw: Net lease properties that feature investment-grade tenants with long-term leases in strong locations are ideal investments. Just hold these through any stage in the market cycle and continue to make steady cash flows with annual rent increases. My grandfather’s generation called this “mailbox money” because he just got a check in the mail once a month with no on-site responsibilities. A hands-off investment is more important than ever when a principal is seeking a safe, low-risk asset. The key to investing is underwriting the tenant and understanding how important the property is to its cash flows. B+E has developed data and analysis to help clients underwrite properties in this manner.
Net lease single-tenant real estate was the fastest growing segment of commercial real estate before COVID-19, and the segment is now going to generate even more interest. NNN assets can have a lower risk profile post-coronavirus than other types of CRE, given that:
- NNN assets can be found, reviewed and purchased virtually with little hands-on due diligence or maintenance. Most purchasing activity can be handled by third parties. Buyers need to underwrite the tenant and its credit, the lease instruments and terms, and the underlying real estate’s core metrics. Most underwriting simply requires comprehensive market and asset data—both historic and real time. For example, a key difference between a multifamily apartment complex and a typical long-term NNN like McDonald’s is who is responsible for problems found during property inspections. If the roof is found to be compromised during third-party inspections, the multifamily buyer will be responsible for this repair and needs a hands-on inspection to determine real cost and timing. But in the case of the NNN asset the buyer will simply notify McDonald’s, who is responsible for replacing the roof.
- Single-tenant net lease properties do not have common areas that the landlord needs to maintain according to the new COVID-19 sanitation standards. The tenant maintains the property and these standards.
- If the property only has one tenant and that tenant conducts essential services, the landlord can underwrite the entire property as open and operational, despite the crisis. If there are multiple tenants, the rent roll may vary in terms of performance.
- Post-COVID-19 taxes are expected to increase dramatically. Buyers will be looking for tax-efficient investment opportunities. Net lease properties are key targets for 1031 exchange buyers.
- Simply put, a single-tenant property is recession-proof if that tenant offers essential services, has an investment-grade rating and a long-term lease on the property with solid rental escalations.
READ ALSO: Top 5 Mistakes to Avoid in a 1031 Exchange
What are the benefits of using an online trading platform for net lease real estate?
Renshaw: An online trading platform provides more efficient trading, elevating the confidence of both buyer and seller as they can clearly see NNN market activity, who the players are, who the tenants really are, nearly every on-market NNN property available nationwide and real-time stock, and credit and news metrics that correlate with those tenants and properties. You would expect this much data if you were trading stocks. Why wouldn’t a buyer or seller expect this when trading NNN real estate?
What are the challenges of net lease investment? What new obstacles do you think will appear due to the pandemic?
Renshaw: The key is underwriting tenants as you would if you were buying their stock. Landlords often want to hold NNN properties long-term and a stable tenancy is important. Tenants that do not offer essential services are struggling. Obviously, restaurants and retail that cater to dense audiences will need to evolve their physical facilities post-pandemic. This will be expensive and may bankrupt some tenants, creating vacancy in those properties. But if a landlord has a tenant that’s key to the post-coronavirus economy, they will continue to get their “mailbox money” each month.
Which property type is net lease most used for and why?
Renshaw: Single tenant, because it is easiest to assign all property responsibilities to the one tenant. If you have two or more tenants, there are often common areas and their maintenance to contend with. Retail, industrial, office and medical all utilize net lease real estate structures, when a single tenant occupies the property.
How will COVID-19 impact net lease investment in the medium and long term?
Renshaw: As we saw in 2008-2010, investment in net lease properties will likely increase relative to the general CRE market. Buyers will shy away from tenants who were not open during the peak of the COVID-19 crisis. In the fourth quarter of 2020, there will likely be increased demand for investment-grade tenants who offer essential services, keeping cap rates flat to compressed in those categories. We expect a flight to low-risk, secure investments. We expect principals to seek out tax-efficient investments through 1031 exchanges and net lease properties.
Properties that are already experiencing high demand include:
- Single-tenant medical properties including urgent care and pharmacy.
- Distribution centers.
- Cold storage.
- Light and heavy manufacturing spaces, as more demand moves stateside.
- Convenience stores and gas stations.
- Auto service, parts and repair shops and tire stores.
- Pet and veterinary uses.
- Retail uses that cannot be found or serviced properly online, like boutique luxury shops.
- Superstores that blend retail and industrial uses by allowing in-store shopping and pickup and delivery services like Whole Foods or Walmart.
Last year B+E brokered a $324.3 million sale-leaseback transaction that might be the largest commercial real estate transaction brokered by a digital platform. What are the company’s goals for the remainder of 2020?
Renshaw: We continue to take market share, with a goal of $750 million in total sales in 2020. But our real goal is mindshare—our team learned during the Great Recession that you earn your clients and their long-term business during the downturns, not the peaks. We are working hard to provide continued insight, data and relationships to our clients now and post-COVID-19. We believe that by working together, the net lease segment will continue to grow, expand and provide long-term value to property owners and their tenants.
Owning real estate is the American dream. And while many Americans own homes, most do not own commercial real estate. Net lease is the gateway property to that dream, as the ownership responsibilities and expertise required are lower than for many other property types. B+E is working hard to:
- Transform the NNN industry through new technologies.
- Scale the B+E broker and deepen client relationships.
- Expand the NNN marketplace, bringing NNN investment opportunities to women, people of color, Millennials and others who have never before invested in commercial real estate.