Having the knowledge rather than just an understanding of a subject means you have become an expert. So, when it comes to single tenant net lease (STNL) properties, wouldn’t you want to know as much as possible before investing?
This type of lease that’s executed between the developer/landlord and the tenant of the build to suit location solidifies the use prior to development. As a potential buyer of said property, here are a few items you’ll want to review in the build to suit lease before signing the Purchase and Sale Agreement.
First and foremost, the tenant concept and credit profile should be taken into consideration. This will impact the overall terms drawn up in the lease. As a future landlord, your lowest risk option would be to choose the single tenant properties with an investment-grade or national tenant.
National creditworthy tenants with a rating of at least BBB- (S&P) are the standard for premium net lease properties. Also, regional or franchise-type credits contribute to the overall value of the property because it is dependent on the tenant.
In today's market, sub-investment grade product can provide the investor with greater flexibility in lease variation and ability to capture greater yield. The consistency of a freestanding long-term net lease is more uncertain than in the previous decade. So, risk tolerance is a driver of accomplishing a higher yield.
For example, in a SimonCRE-developed regional quick service restaurant (QSR) location in Phoenix, Filiberto’s Mexican Food, there was high demand as this type of concept is both value-oriented and ecommerce-proof. The property was recently sold and the investor was able to achieve a better cash-on-cash return relative to a newly constructed national QSR lease.
In the same vein, in the SimonCRE-developed medical office project in Florence, AZ, it was a smaller operator so there was a higher discount on the exit purchase price for the investor. It is also immune to the effect of ecommerce as it provides an improved quality of healthcare for the community through its new exam rooms, laboratory, and drive-thru pharmacy. Because it is not located within a major metropolitan city, this traditional market highly benefited from this type of concept.
One could argue that single tenant property is the most "liquid" asset class in commercial real estate due to its consistent lease structures and abundance of comparable data. Although, being an expert in how net leases are drafted first involves the knowledge of the different types of build to suit leases.
For example, in an Absolute Net Lease or a bondable lease, the tenant is fully responsible for all building expenses including the roof and structure. Whereas in a Single Net (N) Lease, the landlord covers all building expenses and the tenant pays a pro-rata share of the property tax, utilities and janitorial. Then in a Double Net (NN) Lease, the taxes and insurance premiums are paid by the tenant while the landlord maintains all the exterior and common areas.
Triple Net (NNN) is likely the industry catch phrase you’ll hear most, especially for a retail single tenant net lease; however, it could also vary in terms of tenant versus landlord responsibilities as it is less rigid than an Absolute Net Lease.
The length of the actual lease term and time left are also important deciding factors. Typically, build to suit leases will have terms ranging from 10-25 years. Although, non-national tenants may follow a trend of shorter term leases.
Keep in mind, the cap rate is calculated using the tenant’s Net Operating Income (NOI), so less time left on the lease means a lower risk of failing to renew. Traditionally, cap rates move in lockstep with the 10-Year Treasury. So, when exploring an investment property, evaluate the value of the building plus the raw land to determine if the price is fair or not.
Another point to check when combing through the lease is if there are any periodic rent bumps in place. When do they occur? From a developer’s perspective, having the periodic increases will add to the property’s value. It also serves as a safeguard that ensures the rent will likely keep up with the market rate.
Rent escalators tend to drive more demand from investors seeking long-term passive investments. Consequently, it can also create challenges for redevelopment. Rent increases are meant to account for appreciation and inflation. However, in times of market stagnation, it can lead to operator defaults or even situations where the developer is unable to replace rents. So, this all should be taken into consideration.
At this point in the market cycle, S&P-rated investment-grade tenants are structuring flat leases. But without these rent increases in place, an investor could end up with a long-term tenant paying lower than market rate. It’s critical to consider any economic factors that may affect your income down the line.
A final checkpoint on a single tenant property is to ensure there are multiple lease renewal options drafted. While a property can change hands at any time, it’s always an important selling point.
Having these options protects the tenant but are also crucial for a landlord. Economic factors can impact your income if you’re not prepared for them. For example, during times of a seller’s market where an owner/landlord of a property in an especially competitive area, flexibility in increasing the rate later helps capitalize on the prosperous times.
During recessionary times, even a national tenant like Macy’s could face hardship and need to either negotiate a lower rate to stay, relocate, or close that store altogether.
Possessing the knowledge of how net leases are structured is what will best influence your investment property’s income stream. It’s an ideal opportunity to consider if you wish to invest in real estate for short- or long-term income, but don’t want the tedious tasks of property management.