Net lease investmentsJuly 13, 2021
The benefits of Net Lease investments
By their very nature, these real estate investments are a passive source of income. The burdens of maintaining a property, paying taxes & insurance, and all of the hassles that come with a building get shifted onto the tenant. And this is one of the main reasons net lease investments are so highly sought after. You get paid without doing any of the work.
In addition, these investments provide a reliable source of income for a long period of time. Without any effort, the owners are receiving stable cashflow, or as some might call it, mailbox money, every month for the duration of the lease. The leases tend to be 15-20 years in length, and with options, can even be as long as 50. With built in rental increases, you’re beginning to see why net lease real estate is so popular.
Yet another reason for the growing desire to invest in this niche industry, is the basic fundamentals of commercial real estate. Your equity is protected as it is placed into a real asset, and over the length of the lease, appreciation will only add to the value of your investment. You are building wealth that can be passed down to future generations.
The bottom line, these real estate investments are a passive form of investing that offer a stable cashflow for many years, preserve your equity, and with good real estate fundamentals in place you build value.
Getting Started with Net Lease investments
If you’re new to commercial investing, getting started can seem overwhelming. At Avison Young, our goal is to help our clients understand what they’re getting into and how to make profitable business decisions. You can learn more in depth from our section, Net Lease 101, but to keep moving, here are a few things to look for when evaluating an STNL property:
1| Location 2| Property 3| Tenant 4| Lease
As with all real estate investments, location matters. Is the property in a big city or a tertiary market? Is it on the corner of main and main in a highly trafficked area and do the demographics looks good? Is the area on the decline, is it stable, or starting to experience growth and development? You don’t have to find the property in the biggest or best location, but you do want to ensure there is demand for that location and that there is replaceability if needed. A strong national investment grade tenant can offset a weaker location, however, as a new investor, it’s wise to start off with a solid location and tenant. As you gain more experience and understand the nuances of net lease, you can later leverage this investment into ones that may have more risk.
The condition of the property is a big part of the picture. Is it a well-maintained building with a solid structure and good roof in place? Or, is it in need of work and likely to be difficult to re-tenant without a major capital improvement expense? Obviously, the cost will need to reflect the condition of the property.
Further, is the property built-out specific to one tenant or sector? For example, a property with a drive-thru that’s been used for fast food may be easier to re-tenant with another quick service provider versus a building with garage doors that was once a car repair company. Do note however, that often when these buildings are specific, the tenant has invested a lot into the branding/fixtures/equipment and may be likely to stay and renew for the long haul. All these characteristics play into cost when evaluating the condition of the property.
Choosing the right tenant can often be one of the most important factors in your net lease investment process. Is this a national brand chain with a corporate guarantee? Long standing business with a solid reputation and year after year earnings? Or is it a national brand that has a franchisee guaranteed lease? Is it an operator with an excellent reputation? Make sure to do a full evaluation of the tenant and look at their credit rating. It’s an important piece of the puzzle.
The market place is made up of a variety of tenants, all of which fall into various sectors – quick service restaurants (QSR), pharmacies and convenience stores to name a few.
The lease structure is the last major component of evaluating your investment. Although we won’t go into detail here, you can find more information …
First, you’ll need to understand if it is a ground lease versus a fee simple lease. And is it an absolute triple net lease (NNN) or are their responsibilities dictated for the landlord to handle making it a double net (NN) lease? How much effort you as the owner has to put into the maintenance and care of the property will dictate how much return you desire on your investment. The more effort, the greater the return.
Additionally, how long is the lease and are there options for the tenant to renew? Are their built-in rent increases (rent bumps) to keep inline with the market? There are endless versions to leases and each clause will require consideration. Avison Young’s Net Lease Group specializes in assisting its clients in finding and evaluating leases that match their investment criteria, protecting your equity and building value in the long run. Once
you’ve narrowed down your options, it is highly recommended that you work with an experienced real estate lawyer to review the lease. It may cost a few dollars up front, but in the end, can save you thousands down the road.
So what are the risks?
Though these investments are popular, like any real estate investment, they carry some risk. Their predictable revenue stream and minimum management requirements are strong upsides. However, it’s important to be aware of what risks do exist and how to best mitigate them.
- Tenant credit risk can be an issue when it is not a publicly traded and/or financially sound commercial entity. Require the submission of the prospective tenant’s financial statements. Analyze them carefully. If this is not a familiar process for you, hire a CPA to do this on your behalf.
- If the tenant falls on hard times, they may have difficulty meeting their financial obligations. If they enter into bankruptcy proceedings, this is where the lease guarantee can play a major role.
- In the event of a termination and now vacant building, you’ll want to have an asset that is easily re-tenanted. Solid location, re-usable build-out and well-maintained properties are your best defense.
Don’t be scared! With proper due diligence and guided expertise, you can set yourself up with the perfect investment that provides you with no hassle, a reliable long-term stream of income, and added value as the property appreciates over the life of your investment.
Ready to invest?
If you’re interested in knowing more about net lease investments, give us a call. We’d be happy to discuss your real estate investment needs and determine if this is the right investment for you and begin the search process. But, if you are looking for a hands-on investment that requires day-to-day attention with a quick get-rich opportunity, this isn’t for you. These investments are excellent alternative cash flow investment.