In the decade following “The Great Recession” net lease assets have forged their place amongst the portfolios of real estate investors. The increasing popularity of net lease assets has permitted the capitalization rates (cap rates) of these assets to remain stable, even after significant interest rate increases in recent months. Despite a 62 BPS increase in the 10-Yr Treasury Note yield since Quarter 1 2016, cap rates on single tenant net lease (STNL) properties have decreased 13 BPS over the same time period.
Investors are drawn to the long lease terms, investment grade credit tenants, and the hands off nature of management that STNL properties provide. However, the simplicity of these assets is misleading, and it is important to hire an experienced net lease broker and transaction attorney when you are considering the purchase of a triple net lease asset.
CVS, Starbucks, and Bank of America may seem like the perfect lessee, but it is important to remember than every tenant has a certain amount of risk associated with it. Consider the difficulties the landlords of Border’s Inc. and Sports Authority have faced while witnessing their tenants go through bankruptcy. Net lease professionals will be able to analyze the risk components of the tenant, the length of term on the lease, and the location of the property in a way an investor is unable to.
Another important aspect of net lease properties is the structure of the lease for a NNN asset. STNL properties coming out of the ground generally have 15-year minimum lease terms, and often provide for escalations throughout the primary term of the lease, and options to extend upon the lease expiration. This allows the landlord to receive long term profits from the NNN property. The long term security sounds great at face value, but oversights in the lease can cause headaches and large payments down the road.
When entering into a contractual agreement for an extensive time period that could be up to 75 years in the case of Walgreens, you must ensure that every aspect of the lease leaves you protected in the case of litigation. Legal precedent has exhibited that the courts will defer their ruling to follow the exact language of the lease agreement. The courts presume that each side engaged competent legal advice when drafting the agreement. The wording of the contract should be written explicitly in plain English. Both the landlord and tenant should state their expectations explicitly; as any ambiguity can leave you open to judicial interpretation that does not coincide with your original intent. A simple error such as using the phrase, maintain and repair the roof, rather than maintain and replace the roof, will permit the tenant to avoid replacing a worn roof during their lease term. The best method to avoid large, unforeseeable expenditures is to hire an experienced transaction attorney to analyze every aspect of the lease. The more experts you have on your side of the table, the more hands (and headache) free your NNN investment will be.