Posted by Francis Rentz | April 3, 2015
Are all single tenant net lease investments the same? It is important to know the differences before investing, in this post we will look at evaluating the double net lease. One of the things that make a “net lease” investment in real estate unique from other real estate investments is that you are not just purchasing the building and land. There is a lease component, which in most cases is the most important component of the transaction.
Where Do the Responsibilities Lie?
Every investor in single tenant net lease properties would like to have one in which the tenant is responsible for all expenses and maintenance obligations and the investor is collecting what is called “mailbox money”. However with the increasing popularity of single tenant net lease investments, bond leases or true NNN leases have become significantly more expensive. McDonald’s ground lease deals, the quintessential net lease investment, are now trading at sub 4% capitalization rates. Having the tools to evaluate a NN lease investment (one where the landlord has some of the maintenance responsibility for the investment), can allow an investor to purchase the property at a higher cap rate, but underwrite the risk associated with the landlord obligations of the lease.
Net Lease Items
Every lease has its own unique nuances and will describe the parties’ obligations in different ways. It is important to have an experienced real estate attorney or a net lease real estate broker review the financial and maintenance obligations as described in the lease. Here are some of the items to look for in the lease:
- Roof – Most single tenant NNN investments have roofs are what are known as a “built up roof” –which requires replacement every 15-20 years at a cost of $4.00 to $6.00 per square foot. During physical inspection it is important to check and understand the condition of the roof and the useful life left before replacement is required. Additionally, it is wise to note who has access to the roof, in particular how any roof-top HVAC units are serviced and what care is taken to make sure that the roof is not damaged.
- Renewal Options – Pay careful attention to the sequence of events for the tenant to exercise their renewal option. It is increasingly common for leases to require the landlord to provide tenant notice of their right to renew the lease. If landlord notice is required and none is given, the tenant’s right to renew will not expire until the landlord provides notice.
- HVAC Maintenance and Replacement – Is the tenant responsible for the HVAC system or is part of the burden shifted to the landlord? Sometimes the landlord is responsible for major component replacement. The historical income and expense statement will not show this if tenant is handling routine maintenance and the major components have not failed.
- Parking Lot Maintenance – This will include the obligation to maintain the curbing, asphalt, striping and lighting of the parking areas. Many of the drug store leases move some of these obligations to the landlord.
- Exterior Walls – Most NN leases require the landlord to be responsible for “structural maintenance”. One of the over looked items included in structural maintenance is maintaining the exterior walls. If you have and EIFS (aka “stucco”), you will be required to patch and repair every few years. Concrete Block or Split Face Block will absorb water if not kept painted at least every 5 years. Bricks is one of the best low maintenance exterior surfaces.
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These are just a few of the items that need to be considered by an investor considering a real estate investment in a net lease property. Pre-acquisition due diligence is critical for any investor to evaluate their potential obligations as outlined in the lease. Every investor wants an armchair investment that has as few obligations as possible but careful underwriting will allow you to evaluate future landlord responsibilities and financial obligations.
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About Francis Rentz – Francis, one of the founding members of SouthLand Commercial, has more than 20 years of experience, and secured numerous transactions valued at more than $100 million. He specializes in commercial properties and land in the northwest Florida market. Click here to view his full profile and listings, or if you would like to contact him, you can call him at 850-877-6000, or email him at firstname.lastname@example.org.