NNN Properties - Making Your Money Work for You
Business has been generally considered better occupation than services for generating wealth. ‘Did you consider doing business in USA’, published in AZIndia Times, January 2019 edition, may interest you in this context. In my daily work, I often come across highly accomplished professionals who have built up sizeable savings. They are possibly from every profession including engineering, medical, dental, IT, finance. Those professionals invariably ask me a question, what could be a good business investment for them with no or minimal management responsibilities? My answer to them is NNN properties.
What is NNN Property?
NNN Property, often pronounced as triple net, is a property leased out to a tenant who agrees to pay, in addition to a monthly rent, (i) property tax, (ii) property insurance, and (iii) property maintenance costs. Did you notice the three ‘nets’? The monthly rent, net of property tax, property insurance and property maintenance cost; hence the NNN.
Residential Rental Market
At this point, you might be reminded of the conventional residential rental market, that has been big, broad, and there for years. All of us, who, and when, couldn’t buy home, rented. There are some, of course, who could buy, but didn’t buy; and instead rented. These are the people who want to leverage their liquidity. This is quite common in commercial property segment and we shall revert to that momentarily. In any case, the residential renters have been such a big constituency that it has always attracted the attention of, among others, politicians and lawmakers. You must have heard rent control legislations. The rental income is generally classified as passive income. In the conventional residential rental market, the landlord receives monthly rent and takes care of property management, property tax, insurance and maintenance costs. If the landlord does not have time and inclination to manage residential rental, the services of a property manager may be hired, for a fee. As an investor, in residential real estate market, fix and lease or multifamily properties are the options worth considering.
Commercial Rental Market
In the commercial property segment, leasing is more common than owning. The reasons are simple to understand. Commercial properties tend to be more costly. The businesses are risky, and the business owners’ preference to leverage their liquidity to add and expand their businesses. It is in this market that NNN is a great option available to investors. NNN frees landlord of the three responsibilities of paying property tax, insurance and maintenance costs. The landlord gets the rent, net of these costs. From the Landlord’s perspective, it is a great way to make your money work for you. There is also a possibility for the landlord to borrow to partly fund NNN properties and thereby leveraging their equity. Since NNN are hard assets, Loan to Value (LTV) ratios of 65- 70% are common. From the Renter’s perspective, it is like a sale and lease back the property. As a result, they can liquidate their fixed assets; free up cash; and leverage their liquidity into business.
Investment Considerations
NNN properties are popular among investors because there are no management responsibilities, stable cash flow and standard real estate tax benefits. However, as with any investment, there are certain factors that must be carefully considered when investing in NNN properties. These include location, tenant, lease terms, building and financing available. Also please check out, is it really NNN property?At times, NNN properties are offered with owner responsibility for the roof and structure. That responsibility should be carefully weighted in the investment decision.
Bottom- line
The bottom-line financial numbers in NNN properties are the Cap rate and Cash-on-Cash (CoC) or Return on Equity (ROE). Cap rate is the annual rent divided by the purchase price. CoC or ROE is the annual rent, net of borrowing costs, divided by down payment or equity. It is important to know that these numbers can significantly vary due to property specific and macro factors. Property specific factors include remaining lease term, credit rating of the tenant, possible alternative uses of the property. The macro factors include changes in interest rates and disruptive innovations in markets like tech- enabled digital businesses substituting physical businesses, ‘shared’ economy substituting ‘exclusive’ economy, and ‘functional’ economy substituting the ‘life style’ economy.
To begin with, you may look for NNN properties, which are corporate guaranteed, remaining term multiplied by cap rate greater than 100%, tenants in food or health or storage and warehousing, and lastly fixed rate loan at a rate lower than cap rate. If you are short of equity, may consider syndication. If you don’t step on those properties instantly, better be patient and keep the eye out.
Sat Parasharis former Director, IIM Indore and currently Director, International Business Development, American Motel Hotel Brokers Network, and Financial Services Professional with MassMutual Arizona. He is also Adjunct Faculty at Rady School of Management, University of California, San Diego, CA.
By,
Sat Parashar, PhD
parashar.sat@gmail.com