Net Leased Real Estate As an Alternative Investment

On Wall Street there is a renewed interest and enthusiasm for conservative investing. One asset class that is getting noticed is Net Leased Real Estate.

Net leased real estate can be everything from buying a Walgreen Drug Store to one of the many dollar stores that have proliferated in the past few years such as Family Dollar and Dollar General. Other typical property types offered are automotive service and parts suppliers such as a building leased to Bridgestone/Firestone or an Advance Auto. Also worth noting are some highly sought after FedEx Ground distribution properties or bank branches.

These properties are usually built on contract by a developer for the user/tenant with the tenant signing a long term lease, 10 to 25 years. Because the developer has committed to building several locations for the user/tenant he offers the assets for sale to the investing public. The investor buys the real estate fee simple, i.e. the investor is not buying a stock but the building along with the lease.

Most of the leases are triple net or double net. Triple Net is a term that refers to the tenant paying all costs of the lease such as taxes, insurance and common area maintenance (CAM) and in many cases responsibility for roof and parking lot replacement along with integrity of the structure. Double Net has the owner/landlord ultimately responsible for the roof, structure and parking lot replacement. The term single Net can have varying meanings and a close reading of the lease in all cases will determine who is responsible for what.

Who Should Purchase Net Leased Real Estate?

The investor that does not wish to purchase shares in a real estate fund such as a stock in a REIT or a TIC, is a candidate for fee simple owned net-leased property. The most often mentioned drawback to fee simple real estate investing is the illiquidity factor. For this reason, net-leased investment real estate should be considered only for the “Qualified Purchasers”, those with at least $5M to invest or the “Accredited Investors”, those with $1M of net-worth or income greater than $200,000. Many professionals form partnerships to purchase such assets and meet the above criteria and spread risk.

How are Net Leased Properties Valued?

Investment real estate values are expressed in terms of Capitalization Rates commonly referred to as “Cap Rates”. By definition, a Capitalization Rate is “any divisor (usually expressed as a percentage) used to convert anticipated economic benefits of a single period into value.” Many times, this divisor is computed by accumulating differentials of risk associated with the stream of economic benefits being analyzed. Generally speaking, with respect to the economic benefit stream of a real estate investment, a pretax cap rate is the Net Operating Income (NOI, net income less all expenses before debt service), divided by the purchase price. Or conversely, the NOI divided by the cap rate will be the purchase or selling price.

For example:
NOI = $100,000; Purchase Price = $1,000,000; Cap rate is 10%
NOI = $100,000; Cap Rate 9% (.09); Purchase Price = $1,111,111
NOI = $100,000; Cap Rate 11% (.11); Purchase Price = $909,090

How is a Cap Rate determined? Cap rates, the divisor, associated with a real estate investment are a measure of several determining factors:

a. the credit rating of the tenant;
b. terms of the lease such as triple-, double- or single-net, length of the lease tenure, increases in rent during initial term;
c. cost of financing;
d. location;
e. age and condition of property upon purchase; and
f. long-term viability of location and building.

A property with strong measures of the above will trade (sell) for a low relative cap rate reflecting the strength of the overall investment, conversely, the higher the cap rate the greater the risk.

The good news at this time is that cap rates for all offerings are rising making it more affordable for those looking to make a purchase in the near future. Financing a net leased property with a credit tenant is surprisingly easy for qualified individuals or partners.

Ned Coyle, CCIM, is an Investment Specialist with concentrated emphasis in the practice of representing buyers of single tenant, net leased properties. These assets are located throughout the U.S. He has three decades of commercial real estate experience and has extensive understanding of valuation analysis and enhancement and has worked on behalf of local, regional and national corporations and banks as well as high net worth individuals and REIT’s.

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