Triple net leased properties, also known as NNN real assets, are defined by their lease agreement. The tenant is responsible for paying all operating expenses associated with the property outside of utilities and mortgage payments. NNN properties are considered to be a stable, low-maintenance, income-producing, bond-like investment that also retains the growth and tax advantages of real estate.
Triple net lease properties are also referred to as "mailbox money", as such NNN lease brokers are the only commercial real estate professionals that can probably make a rap song out of their property type and reach the number one spot on the billboard charts. "I got that mailbox money, I said I got that mailbox money, say what, I got that mailbox money" I digress, triple leased properties are particularly popular amongst the high-profile single tenant corporations. NNN assets are often used in 1031 exchanges for their tax benefits.
Triple Net Tutorial
First, let us review a few uncomplicated lease structures. Most readers are familiar with a gross lease, which are all-inclusive and standard in residential housing. Gross leases consist of a predetermined rental fee, and all expenses are usually paid by the landlord. In a single net (N) lease, the tenant pays a pro-rata share of the building's property taxes. A double net (NN) lease requires the tenant to cover a pro-rata share of the building's taxes and insurance, and a triple net (NNN) lease requires the tenant to cover property taxes, repairs & maintenance, and building insurance. Typically, NNN leases are most often used for freestanding commercial buildings, which are occupied by single tenants from various industries. These businesses boast big names tenants from high-profile chains such as Olive Garden, Dominos, Chick-fil-a, Sheetz, Jiffy Lube, 7-eleven, and one of my personal favorites...WAWA!
Capital Markets
For the most part, these types of businesses provide people with basic retail consumption needs ie fast food, gas, and groceries, which is considered by investors to be a recession-proof property type. From an investors perspective, a NNN leased property should reflect the tenant's ability to meet all terms over the tenure of their lease. This is shown in the cap rate as the higher the credit risk equates to a higher the cap rate. According to the Real Asset Adviser, "due to low yields from traditional bond funds, many institutional investors are turning to other types of alternative investments such as triple-lease funds for bond-like security and added yields."
Acquisition Due Diligence
Investors diversify across geographies, tenant credit quality, asset classes, lease durations, and industries in order to provide safety and a continuation of income. Investors evaluate base rent and expenses, as well as historical sales to determine potential future income. Investors view net lease properties as defensive, thanks to their long-term leases that generate stable and predictable cash flow.
Advantages & Disadvantages
It's obvious that NNN leases tend to be more landlord-friendly. So you're probably wondering why a tenant would sign a triple net lease agreement. Typically, businesses would rather lease their real estate as opposed to owning it, and leases are between 10 and 20 years with annual rent increases. Hence, keeping the actual property off their balance sheet. The Real Asset Advisor quote the CEO of VEREIT, Mr. Glenn Rufrano, saying "we are in the business of providing capital to Corporate America by providing long-term housing for their businesses". The benefit for the landlord is not having to foot the bill for tenants wasteful utility consumption or extreme usage of rentable square footage that typically leads to costly damages. The risk for the tenant involves a loss of control over increasing expenses and budgets for repairs that can hinder cash flow that could otherwise be used for investment in operations, marketing, or human capital. The risk for the landlord is that a tenant can go bankrupt and the property could go dark (vacant), which would disrupt what was once a predictable income stream.
Conclusion
Triple net lease properties performed well in 2017. Many companies enjoyed a boost in revenues over the holiday season and the development pipeline for new supply has been subdued post GFC. Interest rates are expected to rise over the next few quarters and this may make it difficult for institutional and private investors to explain their purchase price as cap rates have compressed to all-time lows. This has led to a flight to quality as foreign investors have their eyes set on NNN assets as a way to diversify their real estate holdings.
In my opinion, the future is bright for NNN lease properties, unlike mammoth malls in the middle of nowhere, triple net properties serve their communities by providing necessities that only take a few minutes to an hour to obtain. A few months ago, I wrote about the proliferation of investment in industrial real estate due to a changes in consumer consumption. I believe NNN assets are experiencing a similar trend. As a result, many of the top brokerage firms (CBRE/JLL/HFF) have recently established advisory teams that solely focus on triple-net leased properties as the appetitie for this property type continues to increase.
