NNN Properties typically are valued using their Capitalization Rate also referred to as Cap Rate. NNN Properties cap rates reflects the value of a stream of economic benefits discounted for time and risk. Generally this is computed as a pretax cap rate using the Net Operating Income (NOI) for NNN Properties.
How are NNN Properties Valued?
NOI is income less all expenses before debt service. The Cap Rate is the NOI divided by the purchase price for NNN Properties. Conversely the NOI divided by the Cap Rate will equal the purchase or selling price.
Example of Cap Rates for NNN Properties:
NOI = $100,000/10%=$1,000,000 Purchase or Selling Price
NOI = $100,000/$1,000,000=10% Cap Rate
Some of the major considerations when calculating Cap Rates for NNN Properties are:
How are Cap Rates Determined for NNN Properties?
The more positive the above factors for NNN Properties, the lower the Cap Rate or the higher the value of the property related to its income stream. Conversely if the above factors for NNN Properties are weak the Cap Rate will be higher and the resulting value will be lower reflecting the greater risk of the investment.
It is important to remember that markets are not perfect and low Cap Rate NNN Properties are not necessary a lower risk investment, they could simply be a bad investment that is over priced. Astute investors seek NNN Properties that are mispriced in their favor, namely a higher Cap Rate for a property that has lower risk factors.
In a build-to-suit the landlord builds the improvements for the tenant and the tenant leases them back typically on a Net Lease. The Net Lease rent payable by the tenant is a function of the construction and financing costs of the project. This arrangement allows the tenant to move in and occupy the property with zero initial cost.
What is Build-to-Suit?
The Net Lease rent is fully deductible over the lease term, making the tenant's after-tax cost less than with alternative forms of asset-based financing.
What is a Ground Lease?
A ground lease is a method for separating ownership of the improvements (building) from the ownership of the underlying fee (ground). Typically ground leases are long term Net Leases where the tenant pays all expenses except debt service. Any financing for the improvements are paid for by the tenant. In some cases the ground lease is subordinated to the debt on the improvements.
On unsubordinated ground lease, no lien is placed against the fee simple title to the land. Instead, the leasehold estate is the primary security for any debt on the improvements. There is no depreciation with the ownership of a ground lease.
Many investors favor ground leases because they don't need to use their own funds to build the improvements yet end up owning the improvements on termination of the lease. When the Net Lease ends the improvements revert to the owner of the ground lease the owner benefits from the full rent for both the land and the improvements.
Tenants like ground leases because they reduce the tenant's cost of development by eliminating land acquisition costs. A long term Net Lease provides predictable rent payments that are deductible by the tenant for federal and state income tax purposes.
Typically ground leases are long term Net Leases and include set rent escalations, foreclosure rights and reversionary right (improvements revert to owner of ground lease at termination of the lease).
A Real estate sale leaseback is when a business sells its commercial property for current market value and then leases it back typically using a Net Lease. The seller retains the use of their real estate and frees up capital which can be used to invest back into the business. Real estate sale leasebacks are popular because they generate capital for immediate use within the business.
What is a Sale Leaseback?
A long term Net Lease on a sale leaseback create a predictable rent that is deductible for federal and state income tax purposes Some businesses do sale and leaseback transactions for equipment as well.
NNN Properties are generally categorized as either true triple net (NNN) or double net (NN). The distinction between NNN and NN leases is an important one as can be seen in the following definitions.
The tenant pays operating expenses such as maintenance, repairs, taxes and replacement for the entire property, without limitation. The owners pay the mortgage only. This is the type of lease that most investors expect when purchasing NNN Properties.
Absolute Triple Net (NNN)
A bond lease is a slight variation on the true triple NNN lease because the tenant is required to absolutely comply with their rent and operating expense obligations regardless of extenuating circumstances affecting the property (i.e. Even if the property is under eminent domain proceedings).
Bond Lease (NNN)
Similar to NNN leases but with additional owner responsibilities. The owner is generally liable for the structural components of the building such as the roof, foundation, load-bearing walls and parking. Leases will vary so they should be carefully read.
Double Net Lease (NN)
For investors considering NNN Properties but who would like to invest less capital (cash) and still have little to no management responsibilities Fractional Ownership can be a good option to consider.
Net Lease Alternative
Advantages of Fractional Properties are the lower minimum investment (starting at $100,000), greater diversification, prepackaged financing (if any) and due diligence material. Unlike a stock, or bond Fractional Ownership can qualify for 1031 and 1033 exchanges providing they follow IRS guidelines.