2021 Top Picks: Investors Target “Magnificent 7” NNN Investments
Guaranteed leases signed by top investment-grade retailers are proving to be bulletproof even during a pandemic.
Sid’s Diner in El Reno, Oklahoma may have a definite claim to fame as producing one of the best tasting burgers in the country – at least according to some food critics. Yet when it comes to the NNN investment market, it doesn’t hold a candle to the star power of McDonald’s.
Having a signed lease guarantee from a highly credit rated company like a McDonald’s Corp. is a bit like holding a golden ticket. Similar to how you want to screen for good tenants if you are renting your house or apartment, for triple net lease you want tenants that are reputable, have a proven business model, can pay rent and guarantee it. The “guarantee” in this context means that the tenant, or parent company of that tenant, would be responsible for the rent payment obligations, even if the tenant itself vacates the premises/property during the term of the lease.
For example, if you own a NNN property with a 20-year lease to McDonald’s, and for whatever (highly unlikely) reason that restaurant closes 7 years into that lease. The lease guarantee would obligate McDonald’s to continue paying rent on that property for the remainder of the lease term - another 13 years – even if the restaurant is not operating and the building remains completely empty.
However, the value of the lease guarantee is only as strong as the company standing behind it. If Sid’s Diner were to close down in the middle of a 20-year lease, it’s entirely likely that the rent checks may disappear right along with it. So, how do you quantify the value that lease guarantor adds to a NNN investment? One easy resource is referring to credit ratings on publicly traded companies that are available through agencies such as Standard & Poor’s or Moody’s. The agencies analyze and track financials of hundreds of companies on an ongoing basis. Their corporate ratings provide a quick and easy reference when underwriting credit quality of tenants backing leases in commercial property.
In the context of corporate credit, the most attractive net lease tenants for many of my clients are national chains and publicly traded corporations that have sustained successful business models. The “Magnificent 7” that rise to the top in the NNN marketplace include Walgreens, CVS, 7-Eleven, McDonald’s, Dollar General and Firestone Complete Auto Care. They all boast investment grade credit standing with an S&P investment grade rating of BBB- or better and garner the most attention from investors. Although they have always been a favorite amongst net lease investors, their popularity has surged higher in the wake of COVID-19. These net lease tenants all fall into the “essential retailer” category, which allowed them to continue operating during the pandemic even as other businesses were more severely impacted by lockdowns. Let’s check out each of the Magnificent 7 below.
7-Eleven (S&P: AA-, Moody’s:Baa1)
7-Eleven Inc. is the world’s #1 convenience store chain with total store sales of $99.7 billion. 7-Eleven operates, franchises or licenses more than 67,000 stores in 17 countries, including more than 11,800 locations in North America. 7-Eleven is also one of the nation’s largest independent gasoline retailers. Its stores, which are open 24-7, carry some 2,500 different products. The company is continuing to grow its footprint of locations. Their leases are typically 15-year NNN, with multiple 5-year renewal options and rent increases throughout.
In addition, many new 7-Elevens have a convenience store and a gas stations operation on the same site. For those properties, investors can take advantage of additional tax benefits. The IRS allows for a potential 15-year accelerated property depreciation benefit for properties where more than 50% of the gross sales are attributed to fuel sales.
Firestone Complete Auto Care (S&P:A, Moody’s:A2)
Firestone Complete Auto Care, owned by parent company Bridgestone (NYSE: BRDCY), is the world’s largest tire company with $32.9 billion in annual revenue, 143,600 employees and 2,200 locations nationwide. Tire sales account for 83% of the company’s business, with sales about evenly split between the Americas and the rest of the world. Firestone has continued to grow its retail footprint, opening more than 80 new locations over the last two years. Their leases are typically 15-year NNN, with multiple 5-year renewal options and 5% rent increases every 5 years.
McDonald’s (S&P:BBB+, Moody’s: Baa1)
McDonald’s Corp. (NYSE:MCD) is one of the world’s most well-known brands. It holds a dominant share in the quick service restaurant segment with nearly 40,000 restaurants worldwide serving 70+ million people each day in more than 120 countries. In 2019, systemwide sales eclipsed $100 billion with an employee count of 205,000.
Although more than 85% of McDonald’s are operated by franchisees, McDonald’s Corp. typically signs the lease guarantee for all of its franchise locations. McDonald’s has earned a reputation for being a “real estate company that happens to sell hamburgers” due to its tendency to own a majority of its real estate locations. The limited supply of NNN properties for purchase greatly benefits investors that can get their hands on them. The leases are typically 20-year NNN ground leases with the potential for up to 40+ years of renewal options and rent increases throughout. Given its stature as an iconic brand, coveted locations and constrained net lease inventory, McDonald’s generates some of the lowest cap rate transactions (relative higher price) amongst net lease investment deals.
CVS (S&P:BBB, Moody’s:Baa2)
CVS (NYSE: CVS) is a retail pharmacy heavyweight with over 9,900 locations, $256 billion in total revenues, 300,000 employees and a current ranking of #5 on the Fortune 500 list. The company has a growing strategic initiative of MinuteClinic walk-in medical clinics at over 1,100 CVS locations and Target stores that provide patients with convenient, personalized care. CVS leases are typically 15-20 year NNN with up to several 5-year renewal options with rent increases. However, some of their locations do have a built-in 3-year “rent holiday” at the end of the base lease term, which makes it somewhat less attractive to certain net lease investors.
Dollar General (S&P:BBB, Moody’s: Baa2)
With its “Save Time. Save Money. Every Day!” tagline and a 75-year history of delivering value to shoppers, Dollar General (NYSE:DG) is a leading discount retailer with over 16,000 locations in 46 states. Dollar General generates over $23 billion in annual revenue, not to mention boasting 29 consecutive years of same-store sales growth and over 50% market share in the dollar store category. The company has been on a torrid growth path with and average growth of 900-1000 new stores added yearly over the past five years.
Given the backdrop of the global pandemic and status as an essential retailer, Dollar General is now considered by many to be a perfect “flight to safety” asset, and the buyer demand over the last several months has gone through the roof. Due to the fact the Dollar General has a large percentage of their stores in rural or tertiary locations, the cap rate is reflected accordingly with 15-year NNN leases and multiple renewal options that are transacting in the ~6% cap rate ranges. However, cap rates have continued to compress rapidly over the last several months due to overwhelming market demand.
Walgreens (S&P:BBB, Moody’s:Baa2)
Walgreens Boots Alliance (Nasdaq: WBA) is the largest retail pharmacy, health and daily living destination across the U.S. and Europe combined. The company has more than 18,500 stores in 11 countries including 9,500 in the U.S. It also is one of the largest global pharmaceutical wholesale and distribution networks and employs 415,000 people. The company reported $136.9 billion in global sales and ranks #19 on the Fortune 500 list. Walgreens has long been considered to be the “grandaddy” of triple net lease. Its stores are usually located on Main & Main intersections at some of the best traffic corners in any city. Their NNN leases can be up to 50 years or more and are typically structured with a 15-20 year base lease term and up to 10 or more 5-year renewal options.
______________ (Insert Your Top Choice Here)
All six of the above tenants are clearly at the top of their game in their respective fields, and that certainly shows up in a stellar credit rating. What about #7? It is important for investors to recognize that the list of top credit tenants is not necessarily an exclusive club. There are plenty of business concepts that have the potential to be great NNN tenants and fill that #7 spot. There are exceptional companies that fly below the radar of the credit ratings agencies and are unrated simply because they are privately held. Case in point is In-N-Out Burger. This private company is one of the industry’s pioneers, having grown to 300+ locations over its 60-year history and has arguably an expansive base of cult customer followers that spans generations.
Anyone who has ever owned real estate understands what a huge difference having a good tenant in place can make. Everyone wants a tenant that follows the rules and pays rent on time. For NNN properties, the credit rating of the tenant, or more specifically the entity that is signing the lease guarantee can make a big difference between having a “good” tenant and a “generational ” tenant. As such, it is critical for investors to pay close attention to credit quality, and the Magnificent 7 certainly offers a great place to start. To gather the latest marketplace trends and insight of these top-tier NNN tenants, or whether a NNN investment property is the right fit for your financial freedom lifestyle goals contact Andrew Vu at 415-539-1120 for a complimentary strategy consultation.