NNN State of the Union and Survival Guide
The NNN market segment has heated up after a robust and very competitive first half of the year. There are more buyers and less product available—high quality properties are especially scarce. Cap rates have fallen, with long term leased high quality locations and strong tenants in infill locations currently trading in the 5.0-6.0% range. According to senior NNN investment brokers and industry luminaries, cap rates and demand for properties have not come up as a result of the recent run up in interest rates. Buying NNN outside of core markets on both coasts continue to trend as many trade buyers are seeking more attractive returns. What does all of this mean for investors?
For starters it means increased competition, compressed cap rates in spite of rising interest rates, and a stressful sell and exchange process. In many cases the biggest issue is the trade. As the market continues to get stronger and inventory dwindles, investors are looking to us to provide guidance while exchanging from traditional multi-tenant managed assets into the NNN space.
Consider these guidelines when securing debt for NNN assets:
- Borrow long term unless there is a specific short term event that ownership must address (defined hold period) or would like to take advantage of (rent bump). We do not expect interest rates to stay within the current ranges long term, so securing long term debt in line with the lease term or longer could limit refinance risk. Keep in mind that future returns are typically driven by rent increases, and if rents do not increase and rates rise, values could go down.
- Although higher cap rates are obtainable within secondary and tertiary markets away from the coasts, be prudent in evaluating rents, occupancy costs, and viability of the tenant within the local demographic. Most lenders are going to drill down on the occupancy costs and rents (particularly local market rents versus single tenant NNN rents).
- Make sure your lease is in fact NNN. There are many tenants whose lease states that they are responsible for insurance, although the coverage is not always sufficient enough to satisfy many lenders’ requirements. This results in additional landlord expense and management.
- Get tenant financials and store sales—if we know how well a tenant is doing, we can potentially secure more attractive financing.
- Make sure the tenant that you think is guaranteeing the lease is not using a shell entity or weak entity to sign the lease. Consult with your attorney to review the lease and lease guarantee for authenticity.