A financially savvy and well-respected friend said recently, “I want to own real estate, not operate it.” That is when it all clicked and suddenly made sense.
Sure, you can always buy an apartment building and hire third-party management, but this comment was different. The tone of his statement meant something else. He was referring to investing in triple net leases.
A triple net lease is an agreement on a property where the tenant or tenants promise to pay all expenses, including rent, real estate taxes, building insurance and maintenance. The investor gets to own property and do nothing … well, almost.
Understanding triple net
You can sign a triple net lease on any type of commercial property. Think of triple net leases merely as a tool for passing on the building responsibilities to tenants.
However, not all leases are created equal. Generally, leases can be categorized as single net (N), double net (NN), triple net (NNN) — also known as absolute net leases — and ground leases. The last category provides the most passive position for the landlord.
In a single net lease, the tenant agrees to pay property taxes in addition to rent. The landlord pays for everything else. Typically, these are less common.
Double net leases are agreements where the tenants are responsible for rent, property taxes and insurance costs. The landlord is responsible for the maintenance, such as the roof and structure.
Triple net, or absolute net leases, are the holy grail of commercial lease structures. This structure passes all three primary expenses onto the tenant: insurance, taxes and property maintenance. A majority of fast-food restaurants and other retailers heavily rely on this structure.
Another variation on the same theme, ground leases are where the landlord rents the land to a tenant, who builds a structure to use for the life of the lease but then returns possession of the improvements back to the landlord after lease expiration. Under these types of leases, unless stated otherwise in special provisions, landlords are responsible for nothing more than making sure their monthly rent comes in on time.
After understanding the definitions, a broker may want clients to pour money into triple net properties. Not so fast, hotshot. Let’s dig a bit deeper and review the important pieces of a fundamentally sound net lease investment that a broker should discuss when diversifying an investor out of a more active approach.
Focus on dirt
It’s the dirt, not just the lease. Acreage, access, nearby retail, rent and demographics are not just buzzwords — they are important parts of solving the investment riddle. Investors who ignore this fact may end up losing their property investment. Novices buy leases; professionals purchase real estate. With that in mind, here is a closer look at some key aspects of a deal:
- Acreage: Size matters. Too small (under 0.5 acres), and you may encounter functional obsolescence — only a handful of tenants fit on sites that size. Too big, and you are overpaying for useless dirt — unless it is leasable bonus land, and then you’re a genius.
- Access: The dealbreaker. The demos could be perfect, and it could be the correct trade area and even the desired block. However, if customers can’t get in (ingress) or out (egress) with convenience, your tenant is out.
For example, say you are searching for a site for a new coffee drive-through brand, backed by big money with a blank check. Which site do you buy? Likely, you would choose a site at a lighted intersection, positioned on the right-hand side of the road when morning commuter traffic is heading toward the highway. Ideally, it would be an outparcel to an anchored grocery store that would drive additional traffic to the potential site. That is your winner.
Retail rules
Neighbors matter. Would you choose to be near a Chick-fil-A, a Whole Foods grocery store, a Target department store and a Firestone Tires shop; or a local pop-up eatery, a vape shop and a discount clothing store? Both groups have value in the marketplace and play a role in the retail environment, but think about how they impact prospective tenants. Lean into your competitive advantage and investment profile.
Know your market rents. Say you paid $500,000 for a 2,000-square-foot building and you charge tenants $15 per square foot, netting $30,000 annually. This means the building has a 6% cap rate, which is calculated by dividing net operating income by the purchase price.
If comparable properties nearby are charging $30 per square foot, re-leasing the property at that rate would net $60,000 annually, doubling the property’s value to $1 million based on that 6% cap rate. But if the scenario were inverted, where the current lease rate is $30 per square foot but the market rate is $15 per square foot, the property would drop in value by $500,000 if it were re-leased at the new market rate.
That is why many seasoned investors look for higher-yield, low-rent deals because they offer equity creation if the tenant ever leaves. If not, then the cash keeps flowing.
Understand demographics
The three primary demographics advertised by brokers usually fall into the categories of population, households and incomes. However, many investors go the extra mile by considering other indicators like employment centers, job growth, net migration and education.
Here is a simplified rule of thumb: In core markets (think downtown hot spots), you can typically loosen your focus on positioning. But in tertiary towns? It’s worth turning over more stones to find the best dirt. Why? Because if your tenant vacates, you don’t want to be stuck with a building no one wants to rent. Leases expire, but prime locations last forever.
Focus on well-positioned, flexible sites and you can rest easy. So, choose wisely, or sweat your upcoming lease expiration. To choose the right site, stop and consider the following questions to help you determine the quality of your site:
- How flexible are the zoning regulations? Any restrictions?
- Do I out-position other available sites?
- Are there any new developments nearby in the works?
- What is the quality of my neighboring tenants?
- Are demographics trending in the right direction?
- How easily can customers enter and exit the site?
Strategy to success
Triple net investing sounds like a breeze. That’s why most investors fall in love with this strategy once they are introduced to it. But it does take some know-how to size up deals, navigate financing, assess tenant credit, negotiate leases, verify building conditions and consider market dynamics.
At first glance, such details may sound a bit overwhelming for a newer investor or even a seasoned one juggling other responsibilities. But the good news is it just takes some time and focus. Triple net investing isn’t just another gig, it’s your blue-ocean strategy to further success as a real estate professional.
With triple net investing, you no longer are confined to competing in the oversaturated environment of residential deals where everyone is jockeying for the same deals. It’s been said, in a typical year, the top 20% of agents are responsible for 80% of the transaction volume.
This is a chance for brokers to swim in calmer waters. Imagine a broker being able to guide their clients into an investment vehicle that is passive in nature, possesses a tangible land and improvements component, and is backed by some of the companies they are likely investing in for their retirement, such as Starbucks or McDonald’s.
Brokers can help investors realize they don’t have to relinquish their bread-and-butter business models. Instead, triple net investment strategies can serve as another tool in their toolkit. Brokers could even go above and beyond and aid their clients’ recruitment process by incorporating other team members to verify their thinking and make sure they’re not forgetting any key factors. It’s not about knowing every detail right off the bat. What’s important is spotting the perfect client for this type of investment, and pivoting when the time is right. That’s a broker’s edge. That’s how you stand out, bring more value to the table and win that key client.
