Single-tenant NNN properties seem to be the best investment you could currently make in the real estate market. There are good reasons for that: they are one of the only low-risk investment options and don’t require significant experience in the field. Also, NNN properties can yield a profit over a long period, suitable for entities that need a passive income source.
However, it would help if you didn’t fall into the temptation of thinking that NNN investments are flawless or that they don’t have “cons” investors should note. As with all real estate investments, single-tenant NNN properties come with significant pitfalls which buyers must understand before closing the deal.
These risks are the primary determinant for what successful NNN investments are and what they aren’t. The paragraphs below shed more light on the significant pitfalls with which investors shouldn’t trifle.
One would think that location wouldn’t be an issue once the purchase deal goes through and the tenant starts turning in their returns. However, the reality is much different, especially from the location standpoint. The location ultimately determines what happens in the next lease renewal and the subsequent ones after.
If the NNN property exists in a less-than-ideal location, it is challenging to re-lease it if the current tenant doesn’t renew. This leaves you vulnerable to a negative yield, as you might have to re-lease at a lower rent. Furthermore, a marginal area would readily discourage tenants from renewing their lease on your NNN property, regardless of the population or accessibility.
This is an almost direct offshoot of the location issue. If you could get your NNN investments in an ideal area, things would remain rosy only for as long as the current tenant keeps renewing the agreement.
Most Single-Tenant NNN properties have designs and functions specifically for the tenant. As a result, it would cost the investor significant time and effort to redesign, should he have to re-lease.
The situation becomes especially problematic when the concerned building becomes highly specialized to the previous owner. Negotiations with the next tenant would be dicey for you, as they’d expect the property owner to bear some – or most – of the remodeling cost.
It could mean that you don’t get to receive rent for some months, even if your property exists in some of the best parts of the city. One way to avoid such specialization risks is by reviewing tenants’ ability to pay their rents and renew their leases.
Unsurprisingly, single-tenant triple net properties would have no more than one tenant in the lease agreement at any point in time. It means that they can either have full occupancy or be vacant – no in-betweens. You become liable for insurance, maintenance, and taxes once the current tenant leaves.
A vacant NNN property occurs more often than you might realize, as it only takes the occupying tenant to leave due to inability or unwillingness to renew the leases. Therefore, the property remains vacant every time it transitions from one tenant to the other.
The investor incurs the costs until the following tenant signs the lease, which might take longer if the location isn’t right or the buildings now have a specialized design. Commercial real estate investing companies generally recommend that investors attract buyers from the same industry as the previous tenant.
For instance, A NNN property formerly leased to McDonald’s stands a higher chance of getting re-leased to a competing fast-food outlet.
False Corporate Brand Security
A famous household brand would translate to higher-yield tenancy for your single-tenant triple net property, but only some of the time. This is because the lessee is often a subsidiary of the more significant parent corporation behind the brand, and the latter is not always obligated to pay the rent.
Subsidiaries have the part – and most time, whole – obligation to pay rent on your NNN properties, and it is a different situation from the parent brand (which might be publicly traded).
Therefore, investors mustn’t rely on brand name and corporate identity to deduce tenants’ ability to pay their rent.
Wrong Perception of Tenant’s Ability to Pay
It may seem a straightforward thing for tenants to either have the ability to pay their rent or not. However, things are a bit complicated in the real world. The only way the investor can avoid the pitfall is by paying due diligence in reviewing the tenant’s financial status.
Most NNN properties’ buyers are franchise owners to a bigger brand. Legally, Franchisees are separate from the parent corporation and would bear solely lease obligations as tenants with a single-tenant NNN property. The arrangement is not inherently wrong, as franchisees could be creditworthy.
However, some entities could create an LLC “copy” of themselves solely as a front to sign the lease on the NNN property. The parent company invariably gets absolved of obligations to honor the lease should the tenant default on payment. This puts the investor in a fix, as they would have to bear the cost as they find another tenant.
It would help if you paid due diligence on a tenant’s financial setup and the parent company’s availability when there is a default before the lease’s end.
High Interest Rate Risk
NNN investments may be low-risk and ensure steady income over the long term, but it isn’t always so in all scenarios. You’d maintain the revenue consistency to the extent to which the tenant can continue paying the rent and honoring the lease: Large franchises such as Walmart and Walgreens are some of the few lucrative buyer options.
How do interest rates affect an NNN investment? Single-tenant NNN properties have a high sensitivity to changes in interest rate, which is the same as other property options in real estate. However, a high interest rate would spell danger for property owners as their investment’s value drops. NNN property owners would be more vulnerable as they operate a fixed-rent structure.
Luckily, decade-long statistics have shown relatively low interest rates on properties, but there is no guarantee that the trend would continue in the future. If you prefer passive commercial real estate, investing in NNN properties may continue to have the lingering high-interest rate risk.
Single-Tenant NNN properties have the allure of a stable long-term real estate investment. It’s also got a low-risk profile, which may tempt investors to believe that there are no risks at all.
However, the property investment option comes with its peculiar risks and issues you might want to address before going ahead to close the deal. The grey areas highlighted above are some of the more impactful ones but do not deter investors from considering single-tenant NNN properties.
They could help you to make more informed decisions at every stage leading to an actual purchase.