2013 and 2014 have been “red-hot” years for the sale of “single tenant” properties.
Single tenant asset (aka “NNN” or “triple net”) investments where the income property is leased back by a single tenant.
Unfortunately, much too often some of the basic investment fundamentals are overlooked by yield hungry investors. Five of the most common and costly mistakes include:
1. CHASING THE YIELD: with CD’s and banks paying a paltry yield of often less than 1%, investors are clamoring nationwide for better paying yields that can be derived from single net investments. The increased investor competition has driven cap rates well below 5% for strong credit tenant properties. In the past year alone cap rates having dropped more than 100 basis points. This can translate into a price escalation of over 20%. Hot properties today are being snapped up within days of coming to market. Investors need be cautious to not get caught in a price escalation frenzy, and stay true to the fundamentals.
AutoZone: the second largest retailer of aftermarket automotive parts and accessories in the United States. With 5,200 stores across the United States, Mexico, and Brazil
2. UNDERSTAND THE TENANT: While Dollar General and some auto parts tenants are solid blue chip credit tenants, their real estate locations may not be. While these tenants thrive in low income and rural locations, alternative uses may not be viable. In other example, banks that were built twenty years ago were typically larger with lots of drive through lanes. With electronic banking their building footprints may now be obsolete. Same situation with office supply stores and electronic stores.
Walgreens: the largest drug retailing chain in the United States. The company now has more than 8,600 stores all over the United States and its territories.
3. UNDERSTANDING COMPARABLE VALUE: with extremely low cap rates, mathematics can work against the investor. As an example a JP Morgan/Chase building today will trade as low as a 4.5% cap rate. If Chase was paying $50 per square foot, at a 4.5% cap the building would trade at $1,100 per square foot. While the investor may be perfectly satisfied with the 4.5% yield, that $1,100 per square foot building price can easily be 50%-100% more expensive than comparable properties. This will be very problematic should you have to refill that space (rollover risk). In many cases as well, these tenants may be paying significantly more rent per square foot than the prevailing market rate, due to the fact that tenant was provided with a large build-out allowance. Accordingly, the rent will reflect an amortized payback of that investment. The original developer profits immensely because that “added” rent is being resold to the investor at that 4.5% rate. This “funny math” can come back to haunt that investor when the tenant wants to renegotiate the rented rate after that initial term (or threaten to relocate across the street!).
4. CAP RATE COMPRESSION: Cap rate are at all-time low levels. It would be naïve to think that these cap rates will remain low forever (and conversely, prices high). Cap rates and interest rates will eventually move back up to more historical normal rates and so will cap rates (which translates into falling values). Accordingly a single tenant investor must have a very long term horizon, 15-20+ years. Let time be your ally, not your enemy.
5. AVOID SHORT TERM LEASES: One of the primary determinants of value of a single tenant property is the remaining term on the lease. A short term remaining will put the investor at risk should the tenant not renew its lease or want to renegotiate. The bigger the property the more important this is.
There are plenty other factors to consider beyond the 5 traps above: Does the rent escalate? Who is the guarantor of the lease (franchisee versus master entity)? Is it truly a triple net property or does the landlord have responsibilities?
The right single tenant property can definitely have a place in any investor’s portfolio mix when done properly. It’s a great asset for those looking for a low risk real estate asset with little (if any) management duties. Much like a corporate bond portfolio, single tenant properties can be useful additions to a sound retirement plan. Just don’t forget the fundamentals!
Dougall McCorkle, MBA
Sales Associate and Commercial Specialist
Premier Commercial, Inc., Licensed Real Estate Brokers
Direct: 239.213.7234
Cell: 239.860.3368
dougall@premiermail.net