Some more important details to consider when looking over at "triple net leases" (nnn):
First is important to note that the cost to maintain roof, foundation, and walls still belong to the lessor. (i.e. leaks, foundation problems and exterior paint).
Determine the type of real estate involved that a portfolio may hold, since the attractiveness of the nnn lease will be based on the real estate it originates from.
1. It could be office and/or professional buildings
2. Industrial warehouses/distribution centers and within this category, two different types.
2.a Large box single tenant distribution centers, and...
2.b Incubator multi-tenant warehouse.
The reason the above type of real estate makes a difference is because in the first type (Office/professional building) the vacancy factors are usually higher and markets are more volatile, in addition, the turnover is more frequent.
This last characteristic could yield to higher expenses and/or capital expenditures, due to new lessees moving out/in, these costs, (or sometimes improvements), which sometimes are NOT paid by the lessee (particularly in a soft leasing market), will impact the net operating income. (what you look for in a nnn lease).
Industrial buildings by far are the best type of properties, while not glamorous, they have the best occupancy rates, the lowest lessees turnover, and lowest overall maintenance costs (even if it is paid by the lessee, it is important as lessees tend to stay longer where any kind of expense is kept at a minimum.
Also, the CPI escalator clause should give the lessor the option to switch to a regional/local inflation index, in case that the local market has a higher inflation than the CPI.
While single tenant buildings are attractive and even called "coupon clippers", particularly when leased to a recognized signature national lessee. However, they can be risky as they are usually large concrete boxes many times, build to suit the specific needs of the lessee.... so, when a vacancy comes up... you have a 100 % empty building and it will take longer to re-lease, due to its size and the particularities of its configuration, features, and/or specific requirements that were built the first time around, (not to mention potential NEW specifications for the incoming lessee.
Incubator warehouses are more stable, but they do require a bit more management.
The best NNN lease industrial buildings are those that have the following characteristics:
1. Mid size property (25,000 to 40,000 sq.ft.) three to four lessees. (each individual suite, ideally should be larger than 6,000 sq. ft. as a minimum).
2. Concrete tilt up structure. (quicker to build, easier to maintain, cheaper insurance cost).
3. Metal roof, (almost leak-proof, less headaches).
4. Recognized city with strong leasing demand, (cpi escalators will be easier to enforce, and no concessions on the rate).
5. Zoning of Light Manufacturing (usually known as M-1)... heavy manufacturing falls into M-2 zoning and sometimes there are substantial EPA, (i.e. hazardous waste), risk. M-1 should is obviously more desired. (LESS HEADACHES).
6. Upgraded power supply, and accessibility to multiple telephone lines/computer wiring.
7. Sprinkled, fire prevention systems... (lower fire insurance premiums, better usage of square footage, i.e. able to increase build-out areas, such as mezzanines/storage areas).
If direct ownership is sought then it gets better, as usually, depreciation will boost the returns, since said depreciation is offset against income (for tax purposes).... Industrial real estate, typically carries the highest % of improvements over land, yielding higher depreciation allowance, (sometimes as high as 80/20)....
Lastly... it has been said that strip malls, regional malls and other type of retail real estate is now at risk given the Internet impact on society...
Industrial real estate is "Internet-impact" proof. |
