Be Warned - You’re Missing Out By Not Investing In Double Net Lease
Capital often chases NNN, but don’t count out the value of a NN asset
Triple net lease (NNN) has become synonymous with the single tenant net lease investment marketplace. NNN deals are the darling of the industry thanks to the widely touted passive management advantages that investors love. But what about the demands for double net lease (NN) assets?
Double net leases are often overshadowed by their NNN counterparts. NN properties offer some of the same hands-off management attributes. The key difference in a NN lease is that the landlord is usually responsible for the roof and structure of the building. NN leases are common in the marketplace. Oftentimes, a corporate real estate team will sign NN leases as this would minimize potential workflows or expenses such as roof repairs that could negatively impact operational metrics. In fact, national tenants such as Davita and O’Reilly Auto Parts, mostly execute NN leases.
Why invest in NN deals?
Added value: One of the biggest selling points that attracts investors to NN assets is the value. All other factors being equal (such as tenant credit, location and term), NN deals typically offer cap rates that are 25-50 basis points higher than NNN deals. The NNN deals often command a premium simply because they are more popular, and that competition drives higher sale prices.
No more trash, toilets & tenant headaches: Net lease buyers transitioning out of multifamily assets are often so laser-focused on getting out of active management that they bypass NN opportunities all together. The reality is that NN properties can provide the exact same “hands-off” management experience as a NNN property.
Avoiding the cap-ex risk: Doesn’t potential costs related to structural repairs diminish investor appetite for NN deals? Not necessarily. On new development projects, roof or structural issues don’t come into play until many years later. For example, even a minor roof repair is not common until a property is 7 - 10+ years old and the timing of a full roof replacement usually occurs in assets more than 20 years old. Additionally, new development projects typically come with warranties on major structural elements to protect against any fluke problems.
Know your hold strategy: Real estate is a long-term investment, but the reality is that most people don’t hold real estate forever. A common hold strategy for individual investors is 5-7 years. By the time a property needs a major capital improvement to the structure, it might be 20+ years in the future, meaning that it could very well be someone else’s problem. An investor also has the opportunity to buy a single tenant property backed by a NN lease and replace that tenant at some point with a new NNN tenant.
Too good to pass up: Certainly, there are those investors who do embrace strategies to hold assets not just for a few years, but for decades with assets that they can even hand off to the next generation. When that occurs there is usually a compelling reason for acquiring a NN asset, such as a very desirable location that is expected to appreciate in value over time. In those cases, it is important to factor in the physical condition of the building and potential capital expenditures relative to the hold strategy in the underwriting of the investment, as is standard protocol with any real estate investment opportunity.
Tips for navigating NN deals
As with any real estate investment, investors should carefully vet single tenant net lease deals, and also watch out for potential pitfalls. Some marketing packages may tout a deal as NNN to attract bidders – even when it’s really not. Others may market a deal by prominently outlining a list of tenant responsibilities, while omitting the landlord responsibilities in the fine print.
Ultimately, both NNN and NN single tenant assets share a number of attributes and both can represent attractive investment opportunities. However, it also is important to recognize the differences and how it might impact underwriting and return assumptions. At Touchstone Commercial Partners, we believe that every net lease investment requires a 360° view approach to assess factors such as the real estate, location, tenant credit and term. As such, it is important to work with an experienced, reputable brokerage team to help you navigate the net lease investment market.
If you are interested in learning more about net lease assets, and whether a NN or NNN property might align with your investment objectives and lifestyle goals, contact Andrew Vu at 415-539-1120 for a free, no-obligation consultation.