In the past few years “NNN” (Triple Net) leases have been a bright spot in a rather gloomy real estate market. Though this type of investment has been around for many years, it is only with the massive expansion of national chains from McDonalds to CVS and the demand for stand-alone retail outlets, allowed the market to grow exponentially for real estate investors.
Originally this type of investment was conceived to allow credit worthy tenants to build facilities to their exact specifications and needs. At the same time the companies did not have to tie up huge amounts of their operating cash or their borrowing ability in order to invest in real estate instead of their core businesses. Once the building was built, the corporation could sell it to an investor who was willing to trade a guaranteed long term stream of income, without the usual responsibilities of ownership, for a lower return. In the past decade or so this concept has been utilized by retail chains to quickly expand markets throughout the U.S. and beyond.
Since real estate of all type has shown a poor return over the past decade, this is one of the few ways for investors to know, with great certainty, what their return will be year to year over a long span of time. The three great uncertainties for the investor are whether rent payments will keep up with inflation, the residual value of the asset will be once the lease term has concluded, and the long term financial health of the tenant.
For an investor those three points are always central to any real estate investment whether it be a “NNN” one or not. As more and more investors and companies take advantage of the “NNN” concept, the market will see a greater upswing of financial losses for this segment. The investor has to make sure that the tenant has the ability to pay and the continuing need for the space for the full term of the lease and option periods.
The tenant must have the wherewithal to not only make the rent payments but also maintain the premises and pay the real estate taxes and assessments. The investor is accepting the smaller rental payment because there is not operating or capital costs to him. By contrast, in a traditional real estate investment, the investor would be looking for a significantly higher rental rate in order to cover those costs and give him a higher rate of return since there is more management of the asset required.
If inflation at some point during the term of the “NNN” lease becomes significant and the lease does not provide protection, then the investor’s actual cash return after inflation is factored in could be negative. In that event the property value at the end of the term should be higher due to the inflation of the dollar’s value in acquiring a property. While no investment is risk free “NNN” leases may be the real estate investment with the most known risks and outcomes.