Here are answers to some of the most frequently asked questions regarding investments in single tenant, net leased properties.
Q: What is a net lease investment?
A: A net lease Property is typically described as a free-standing facility occupied by a single tenant on a long-term net lease. A net lease investment is similar to a bond backed by real estate in which the Property, owned by an investor or group of investors is leased to a single tenant. Sale-leaseback financing is structured through the sale of a property owned by a tenant who sells it to an investment group and leases it back on a long-term lease.
Q: What is a net lease?
A: There are three main types of leases found in net-leased transactions. The tenant in all of these transactions is responsible at a minimum for paying all costs associated with the Property use and occupancy, real estate taxes, insurance, utilities, on-site Property management and maintenance.
•“Bond-Type” lease or “hell or high water” lease is where the tenant is responsible for roof, structure, etc. regardless of condemnation or destruction of the Property.
•“Absolute” triple net leases, is where the tenant is responsible for all operating expenses, maintenance, and capital replacement.
•“Double net” leases, is where the landlord is responsible for roof and structure, repair and replacement. The lease names vary across the country and in different finance circles.
Q: What is a double net (NN) lease?
A: The landlord is generally responsible for roof, structure and parking lot replacement, and the single tenant is responsible for all other operating costs, real estate taxes, utilities, insurance, maintenance and repairs.
Q: What are the primary benefits of a net lease investment?
A:
1. Security of both the tenant and the real estate;
2. Limited management transaction with minimal costs;
3. Annual cash return;
4. Property depreciation tax defers a portion of the annual cash return;
5. The value of the real estate frequently appreciates during the lease term;
6. Reduced risk with investment grade tenants;
7. The Investor/LLC owns Property with very little on-site management responsibilities.
8. Investor/LLC cash flow (lease income) is net of Property operating expenses.
At any time the LLC, on behalf of the investors, can sell the Property. The LLC can also hold the Property, allow it to further appreciate in market value, and lease it again (generally – although not always - at a higher rate) to the original tenant or a new tenant when the initial lease term expires.
Q: Are there any risks in a double net lease invesment?
A: A tenant may default on the lease and may go into bankruptcy or reorganization. The reserves established for the replacement of the structure, roof, etc. are inadequate at the time repairs or replacements are required. The Investor does not have approval rights for any sale of the net leased investment and must rely on the manager for all aspects of the management and operation of the net leased investment. There is generally no recognized market for triple net leased property interests and an investor may be unable to sell those interests prior to liquidation. Any investment objective may not be achieved due to significant changes in economic and regulatory environment affecting real estate.
Q: What is the tenant responsible for in a double net (NN) lease investment?
A: The single tenant generally maintains and manages the Property on-site. The tenant also insures the real estate, pays property maintenance expenses and pays the property taxes directly to the taxing authority. The landlord is generally responsible for the replacement of the structure, roof and parking lot.
Q: What types of properties are ussually available for net lease investments?
A: Service Centers, Office Buildings, Fast Food Establishments, Distribution Warehouses, Industrial Facilities, Retail Stores, Educational Buildings and Health Care Facilities.
Q: Who should consider a single tenant net lease investment?
A:High net worth individual investors, banks, trusts, and REITs who are seeking real estate investments designed to provide predictable cash flow with tax reduction benefits and the opportunity for long term gains upon sale.
Q: How should an investor/owner evaluate the creditworthiness of a prospective tenant in a net-leased transaction?
A:They should evaluate the financial strength of each prospective tenant on its own merit and as a competitor in its industry. They should consider the long-term stability of the tenant and that industry during good economies and recessions. Industries that provide basic products/services tend to be recession resistant. Investors should also consider any other factors and information they or their advisors deem necessary to make an informed investment decisions.
Q: What makes returns vary on net lease properties?
A:The cap rate (or annual income divided by purchase price) from a double net lease property can vary depending on the financial strength of the tenant. For example, a new franchisee would be considered the highest risk. A multi-billion dollar profitable corporation with good management that has always fulfilled its lease obligations would be the lowest risk and command the lowest rate.
Q: How do you determine yield from a net lease investment?
A: Yield is calculated differently by each individual investor. Some investors use the following analysis:
(1.) Cap Rate - the unleveraged return does not take any tax or depreciation into consideration.
(2.) Cash-on-cash return - the leveraged return (cash income versus cash invested) does not take any tax or depreciation into consideration.
Q: Does the tenant ever have a renewal option in a net lease agreement?
A:Initially, most leases do include a renewal option beyond the original 10, 15 or 25 year typical term. Sometimes, if a tenant does not have a renewal option and when that tenant extensively remodels and improves the property during the term of the original lease, the owner might agree to a 5 or 10 year extension at a negotiated rate.
Investors should always use competent tax and legal experts prior to investing in real estate.
