How to Strike Gold In Triple Net Lease Investments
Undervalued NNN Investments - Your Key to Significant Outsized Returns
California has developed a reputation as being too pricey, with competition and low cap rates that have pushed some local investors to look at opportunities in other parts of the country. The reality is that there are plenty of good investment opportunities – if you know where to look.
The booming investment market is a strong incentive for many property owners to sell out of their actively managed “high-maintenance” properties and roll proceeds into triple net lease (NNN) real estate assets that offer steady, fixed-income and the freedom that goes along with these passive investments. Some owners are reluctant to sell because they’re worried about where to reinvest the proceeds. Are there still buying opportunities in the current hot market – even in California? The answer is unequivocally yes.
In this blog, we highlight another compelling success story that checks all the boxes for savvy investors: A net lease property in an “A quality” location that has upside potential derived from its excellent real estate and a pre-existing below-market rent.
NNN IHOP Santa Ana, CA (click here for more info)
A key mantra to any real estate deal is location, location, location, and this IHOP (International House of Pancakes) asset certainly has an excellent one. Located in Southern California, Santa Ana is the second-largest city in Orange County with a population of more than 3 million. The property sits on a high-traffic out parcel corner of the Home Depot Pacific Center, smack in the middle of a dense residential and business area that generates a study supply of customers for the business. The traffic signal at the corner provides easy ingress and egress, and IHOP is firmly entrenched in that location, having been there for the past 20 years.
IHOP is an iconic brand. It has a cult following for its world-famous pancakes. Founded nearly 60 years ago, the IHOP family restaurant chain has grown to more than 1,800 locations that serve breakfast, lunch and dinner. In fact, forty-five percent of its locations operate 24-7. One of the unique value-adds to this NNN property is that IHOP’s parent company, Dine Brands Global, provides a corporate guarantee on the lease agreement. (That is a rarity as it is more typical for IHOP franchisees to provide the lease guarantee.) Dine Brands Global (NYSE: DIN) is one of the world’s largest full-service dining companies and franchisor of Applebee’s Grill + Bar and IHOP, with a combined 3,530 locations in 17 countries. That lease guarantee is a contractual agreement to continue paying rent regardless of whether an IHOP restaurant is operating in the space. Effectively, that lease guarantee acts much like a corporate bond.
Last, but certainly not least, this investment property has an absolute NNN lease – zero landlord responsibilities! There are 7 years remaining on the base term, and an upcoming 10% rent bump is set to take effect within the next 12 months. The tenant also has three 5-year renewal options with a 10% rent increase in each option – that’s a total of 22 years. What this means to you as a NNN investor is that you have guaranteed rental passive income from IHOP that provides a low-maintenance, worry-free investment whether you are enjoying retirement or simply expanding your investment portfolio.
A Rare Find
This property not only checks the boxes, but is a true standout in terms of its high-quality location, credit tenant, and lease structure. The property sits on a major boulevard at an A+ shopping center and is surrounded by a highly dense population of 277,000+ within a 3-mile radius. Those qualities alone would attract a strong pool of bidders. What is just as exciting is that this property was undervalued.
Valuation of NNN properties is based on the Net Operating Income (NOI) divided by Cap Rate (the equation is Valuation = Price = NOI/Cap Rate). Given that the tenant first moved into this property in 2002, even with triggered increased rents built into the lease over the last 20 years, the tenant currently is still contractually paying rent at 33% - 50%+ lower than the existing market rates. Thus, if IHOP decides to vacate and not renew its lease options, any regional or national tenant would immediately line up to move into this prized location and be willing to pay rent at market rates– an uplift of up to 60% increase in rent compared to rent IHOP is enjoying.
From a valuation perspective, let’s suppose that sometime in the future a new national tenant will be occupying the premises signing on to a long-term 15-yr NNN, with multiple renewal options at $170,000 NNN rent/yr. At a reasonable 4.25% cap rate for this premium location in Southern CA, this property will be worth $4M, well over $1.3M more than what it was sold for in this deal! Also keep in mind that from now until such time that IHOP ever leaves the premises, the NNN investor will still be to reap the reward of a complete passive rental income in the range of $125,000 - $170,000 per year over time through contractual obligations of the lease. Depending on debt costs, that presents a sweet income stream of entirely passive cash flow.
Too Good To Be True?
Yes, this deal sounds a little too good to be true. When a tenant such as IHOP signs a long-term lease in an A-quality location and stays there for 20+ years, it often creates an “under-market” scenario. The same phenomenon happens all the time with multifamily rental properties where you have a long-term owner in place that has benefited from rising values, but has not been aggressive in raising rates. When that multifamily owner sells, he or she often leaves some upside potential for the new owner. In the case of this NNN IHOP, a local investor purchased the property for an undisclosed price with plans to hold the asset over the long term and enjoy a steady income stream.
Even in a highly competitive market such as California, there are hidden gems to be found in strong investment opportunities. The key is to collaborate with a savvy, experienced, and high-integrity broker who can help you navigate the marketplace and who has knowledge of the intrinsic value that can be found in the location, credit tenant and lease term. If you are interested in more information on the NNN investment marketplace, please contact Andrew Vu at 415-539-1120 for a complimentary investment consultation.
