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. Property Damage or Destruction Because of Natural Disasters that can Affect your Tenant’s Ability to Pay Rent
The risk of property damage or destruction because of natural disasters such as hurricanes, tornados, fire, among others, should also be considered . Property damage because an unexpected catastrophe can cause the Tenant’s inability to continue doing business at the location and will affect it’s ability of continuing paying rent as well. Under most lease agreements the Tenant is responsible to carry both Property Insurance for the full replacement cost of the property, and liability insurance. The Tenant is responsible to renew those policies every year and name the Owner as an additional insured on both. Certainly the fact that the insurance could provide the funds to repair or replace the damages to the property, that catastrophic event could still affect the the Tenant’s ability to continue operating and paying rent. Most leases contain specific provisions in the event that the property might be rendered unsuitable to conduct business because of a catastrophe. It is important that as part of the due diligence process you review the insurance policies and coverages, and the lease agreement provisions in the event that the property might be damaged because of a natural disaster.
In summary, 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.
At Casablanca Triple Net Lease Advisors, we specialize in Selling Triple Net Properties nationwide USA. We have helped many clients in finding and negotiating the best triple net property according to their goals and risk tolerance, and we would be glad to assist you as well. We offer our Buyers Free Buyer Representation and We Pay for Your Closing Costs up to $10,000.
If you have any questions, feel free to contact me at 407-205-7570 or you can email me at [email protected].