Top 5 Risks of Buying a NNN Triple Net property and how to mitigate them
Although buying a NNN (Triple Net) property offer singular benefits to investors and can be considered a passive and low risk investment, they are not exempt from major risks that must be addressed, and most importantly determining if those risks can be mitigated in any way. In fact, if we cannot find an adequate mitigator for one of the major risks that we are going to discuss in this article, the property might not be worth pursuing it. Here are the Top 5 Risks of Buying a NNN Property and how to mitigate them.
1. The Risk that the Tenant does not renew the lease or close operations before the lease expires.
This is the main concern for investors and the number one question that I receive from clients, what happen if the Tenant leaves? There are several alternatives if that happen. The first alternative is finding another Tenant that can occupy the property. However, in order to restore the same value to the property the new tenant must be willing and able to pay the same amount of rent that the other Tenant was paying. In other words, to restore the same value, we must restore the same annual income.
There are several other ways to mitigate or reduce the probability that the tenant does not renew or leave such as: making sure that you buy a property with strong real estate fundamentals such as a prime location, strong demographics, the strength of the tenant and brand, an area that is in a expansion with high population and traffic, among many others. At the end of the day if the Tenant is doing good business in that location chances are that they will not want to leave.
The presence of major anchor tenants in the surroundings is also an evidence of strong real estate fundamentals. When there’s a Walmart Supercenter, Target or Home Depot in the surroundings you can rest assure that those big companies did an extensive research of that particular location.
In addition, when you are considering buying a Triple Net property it is very important that you pay attention to the rent per square foot that the Tenant is paying, and the rent to sales ratio. If the Tenant is paying $75 per square foot, in the event that they might decide to leave it will be more difficult to find another tenant that can pay that high rent. In addition, if the annual rent is more than 10% of the Tenant’s annual sales that is definitely a red flag and could affect the Tenant’s ability to pay rent in the future, and will also affect the renewal probabilities.
2. The risk that the existing Tenant might decide to assign the lease or sub lease the property in case that they might decide to close operations early.
All Triple Net leases include a clause that is called Assignment and Subletting. That clause contain the circumstances in which the Tenant can assign or sublease the property without the consent of the owner. Most corporate leases from strong national tenants such as Walgreens, CVS, McDonalds, among others, will state that in case that they might decide to assign the lease they will still be responsible to continue paying the rent until the lease expires. There are other leases that establish a minimum amount of locations or net worth equal or similar to the existing Tenant. We mitigate that risk by making sure that the assignment and subletting clause would leave you in an equal or very similar position that you were with the original Tenant. Ideally, the existing tenant should remain responsible or the assignee should have a similar strength, number of locations and net worth of the existing tenant. It is very important to review carefully the lease agreement and the terms and conditions of the Assignment and Subletting clause.
3. New technologies that can take over traditional business and cause changes in consumer spending and behavior, that ultimately impact the possibility of success of your Tenant.
Technology has created meaningful and drastic changes to consumer spending and behavior, nowadays we can buy pretty much anything in Amazon. Banks as an example have been reducing their number of branches significantly because people have switched to online banking, pharmacies might no longer need those big locations because people now can buy their prescriptions online or in their local grocery stores. The best way to mitigate that risk is by investing in a property in which the Tenant provides a major and irreplaceable necessity to customers, such as food, gas, groceries, health, among others.
4. Major Economic Crises and Disruptions that can Affect your Tenant’s Ability to Pay Rent
The most recent example of a major economic crisis is Covid 19, which caused a sudden economic impact to many businesses and employees. During those days some Tenants could not afford to continue making the rent payments because their were not generating enough sales. The best way to mitigate that risk is by buying a property in which the Tenant provides an essential product or service to the consumer. During those Covid days fast foods, pharmacies, gas stations, convenience stores, dollar stores, health care facilities, among others, continued operating as an essential service and most of them continued making the monthly rent payment without disruption. In those cases in which the Tenant might need some sort of accommodations, a rent deferment could be arranged in which the Tenant can get three or six months without paying rent, and the lease term could be extended for three or six additional months to cover for the deferment period.
5. The risk that the tenant might go bankrupt and stop paying the monthly rent.
The risk that the tenant might go bankrupt as stop paying the rent is certainly another important risk to consider and more importantly find ways to mitigate it. We mitigate this risk by doing extensive research on the Tenant and brand-name financial performance. Analyze the new market trends and new technologies such as artificial inteligence, electrical vehicles, among others. Focus your search on properties in which the Tenant provides an essential and irreplaceable product or services to the consumer.
Two key concepts are important:
- Make sure that you invest in a NNN property with strong real estate fundamentals. Before buying the property, you have to make sure that it is located in a prime location, with strong demographics, high population, high average daily traffic, and preferably in an area that is in expansion.
- Make sure that you buy a NNN property in which the Tenant provides an essential and irreplaceable product or service to the consumer.
Although buying a Triple Net (NNN) property provides many benefits for the passive investor and could be considered a low risk investment, there are major and important risks that the investor you do a closer review and examination. The most important aspect to consider when we evaluate those risks is if we can find an appropriate mitigator that can balance that risk, if we cannot find an appropriate mitigator to a major risk the property might not be worth pursuing it.
Certainly there are additional risks to consider beyond the major ones mentioned in this article, and every property and market present a different risk profile. It is important that you hire a knowledgeable Real Estate attorney with experience in the Triple Net segment that can help you discover those risks and find ways to mitigate them. It is equally important that you must also be represented by a knowledgeable and experienced Buyer’s Triple Net Broker that can help you, not only in the negotiation process, but discovering those inherent risks as well.
The are also many benefits of buying in a triple net property that we discussed in our previous blog article called The Top 5 Benefits of Buying a Triple Net Property.
In summary, the top 5 risks of buying a NNN property are:
- The risk that the tenant might not renew the lease or close operations early.
- The risk that the tenant might decide to assign or sublease the property.
- New technologies that can take over traditional businesses and cause major changes in consumer spending and behavior.
- Major Economic crisis and disruptive events.
- Property damage or destruction because of natural disasters.
As your Buyer’s Broker, I will always tell you all the risks involved in a particular property acquisition, so you can make a well-informed decision.
At Casablanca Triple Net Lease Advisors, we specialize in representing NNN Buyers and 1031 Exchange Investors Nationwide USA. We have the knowledge and expertise to guide you along the way from market research, identifying potential properties, submitting offers and negotiating them, due diligence, up to the closing table. We have helped many NNN Buyers and 1031 Exchange Investors in finding and negotiating the best property according to their investment goals and risk tolerance.
Moreover, we represent our Buyer’s for Free since we get paid from the Seller, and we also Pay for our Buyer’s Closing costs up to a maximum of $10k. This incentive will offset or cover completely the major Buyer’s closing costs expenses such as Title Fees, Attorney Fees, Recording Fees, among others. We are the Brokers that give you more in exchange for your trust.
If you have any questions feel free to contact me directly at 407-205-7570 or you can also email me at [email protected]. Thank you very much for watching this video and I’m looking forward to being your broker in your next property acquisition.