Where Are The Best Cities To Invest In NNN Properties?
High Growth Markets, State Income Tax Rates And Property Taxes Are Three Key Considerations When Choosing Locations
Location, location, location is a common battle cry for real estate investors. But what’s the secret to cracking that code, especially considering the vast number of choices all across the county from small towns to major metros?
We believe it’s important to take a 360-degree approach to evaluate NNN investment opportunities. That approach relies on four key pillars – location, tenant credit, lease term and quality of the property. Here we take a deeper dive into how to vet the best locations.
It’s no secret that people often buy real estate investments close to home. They like the convenience of having a drivable location where they can easily meet with tenants and manage the day-to-day issues that arise. NNN assets are a different story as investors buy NNN properties all around the country. NNN properties offer a truly passive investment opportunity thanks to long-term leases and tenant guarantees from national or regional tenants and offer virtually no landlord responsibility. In fact, over half of all net lease investors have never visited their properties in person. Whether you’re buying a Walgreens property in Kansas City, Denver, or San Diego – the buildings are pretty much the same inside and out, and those properties are backed by the exact same leases signed by the Walgreens corporation.
So, if the world is your oyster, so to speak, where are the best places to buy? Whether you are comparing NNN sale listings in different cities or searching for off-market opportunities, we have a few tricks of the trade. Our approach is to evaluate cities based on three distinct buckets.
#1 Growing Cities: No one wants to buy a property that is in a stale, stagnant or declining market. Property values rise and fall with demand levels, and NNN tenants are chasing those growth markets. If you are buying a property in a high-growth location, the odds are in your favor that you will be able to reap the potential mid- to long-term CORE benefits of real estate – Property Appreciation. For NNN assets located in a high-growth location, if the market rent is $25 per square foot (psf) today, it could be worth $40-$45/psf 15 years down the road. For a 10,000 sf building, the $15-$20 rent/psf difference in market rent can translate to an increase in $3M- $4M in valuation (above what you bought it for), assuming a cap rate of 5%, when it’s time to refinance or sell your building.
According to the latest WalletHub research, California, Texas and Florida are hands down the top states for growth cities.
No of Growing Cities
#2 State Income Taxes: Investors pay income taxes in their home states, and they also are required to file a state return and pay taxes on passive rental income earned for property or properties located outside of their home state. This means that any passive rental income you earn from a NNN property or properties in a nonresident state will be taxed at the income tax rate for that particular state. That is one reason that investors may choose to avoid high-tax states and invest in states with low or even no state income tax. Currently, there are eight states with no income taxes that include:
New Hampshire (set to eliminate income taxes in 2024)
Individual investors may still be liable to pay income taxes for that passive income in their home state, regardless of where that property is located. However, it is important to view location through the tax lens and consider the potential tax implications – to the positive or negative. To that point, it is always wise to consult with your accountant or CPA to fully understand your specific tax situation.
#3 Property taxes: When owning NNN properties, the tenants are responsible for all expenses related to the property, including property taxes. Thus, local and state property tax rates are not a key variable for NNN investors who are purchasing properties with a long-term tenant in place. However, if you are buying a property with a short-term lease and/or a value-add NNN property, it is important to account for leasing risk. If the tenant were to vacate the property when the lease expires, or if you are retrofitting the property to attract a new long-term tenant, you will be responsible for paying property taxes in the interim. Tenant turnover can be a relatively short period of time, such as a few months, or it can be up to a year or more in some cases. Meanwhile, you will be responsible for the property taxes while the building is empty or being renovated prior to the next tenant moving in.
For example, many investors are enamored with buying NNN properties in Texas. It’s both a high-growth state and an income-tax-free state. However, Texas also has one of the highest property tax rates in the nation, currently ranking 45th highest out of 51 states with a 1.8% effective rate. Thus, a $1M building that you are eyeing in Texas may cost $18.5K yearly in property taxes. That’s not exactly pocket change if your tenant vacates – or if you have a non-NNN property, such as an apartment building where the landlord pays for property taxes. A state with no income tax may look great on paper, but the government has to make up the lost income tax stream from other sources. So, while income tax-free states are great, it is important to remember that there is no free lunch.
These three buckets are a good start to narrowing down the list of top locations. The reality is that location analysis is a lot more complex. There are a dozen-plus other criteria to consider when you are on the hunt for the best NNN investments. The value of that location also depends on factors such as good traffic, access, and visibility to name a few. Next, you need to overlay other considerations, such as the growth of the area, co-tenancy, and upside potential. To truly capitalize on the best net lease opportunities, you should partner with an experienced broker. That broker needs to have deep knowledge in identifying quality real estate, as well as the chops to navigate through the intricate maze required to tackle complex real estate issues through each step of the process from vetting locations through escrow closing. To gain the latest insight on the net lease marketplace and assess potential opportunities, contact Andrew Vu at 415-539-1120 for a free, no-obligation NNN consultation.