Interested in learning more about NNN sale-leaseback investments or triple-net lease deals? The experts at R.O.I. Properties have your answers.
What is a Triple Net Lease?
A triple-net lease deal (NNN) is a lease agreement in which the tenant is responsible for all expenses, including rent, real estate taxes, insurance, and maintenance. Investors seeking 1031 exchanges or low-management investments are increasingly seeking out these types of deals.
Understanding Absolute Triple Net Leases
An absolute net lease offers a truly passive investment. The tenant handles all property responsibilities, providing mailbox money income. The tenant covers all expenses, including taxes, insurance, maintenance, and every repair, including the roof, structure, and HVAC. The investor has zero landlord duties. These leases are often long-term and involve creditworthy tenants.
Investors benefit from a completely passive income stream, predictable cash flow, and minimal management. However, absolute NNN leases may have lower cap rates due to the reduced risk. Thorough tenant vetting is even more critical, as the investor relies entirely on the tenant’s performance. Also, there’s less flexibility for rent increases or property improvements during the lease term.
The Sale-Leaseback Strategy
A sale-leaseback is a type of NNN lease that allows a commercial property owner to convert equity into liquid capital. In this type of transaction, the seller relinquishes ownership rights to an investor and then leases back the property when escrow closes. For the seller, the influx of cash from a sale-leaseback can be used to reduce debt, improve debt-to-equity, or fund future expansion — or even to prepare for a business sale or retirement — while maintaining control of operations. For the investor, it creates a transaction that provides stable and relatively uncomplicated income.
What is a NNN Lease in Renting Retail Space?
Typically, a developer will build a retail space to suit a national brand, such as Walgreens, McDonalds, or Starbucks. After securing a long-term lease, the developer may sell the property to investors. Subsequently, there could be several generations of investors who sell and buy with the national — or regional or local — tenant remaining in place over many years. As the popularity of such traditional, national-tenant NNN deals has risen, so has the competition for them.
This increased competition has led investors to explore NNN opportunities beyond traditional national retail tenants. In many instances, they are 1031 deals coming from an investor buying or selling management-intensive assets such as apartments or multi-tenant dwellings, looking to move into something that’s easy, plug-and-play, and offers a nice return.
NNN Retail Trends
A few of the trends we’re seeing in NNN properties in Arizona:
- Lease term flexibility: Traditionally, NNN leases have been 10 to 15 years, but we are seeing a trend toward more flexibility where they can be as short as 5 years.
- Expanding asset classes: Another interesting development has been the acceptance of other asset classes besides retail, including offices such as medical, veterinary and professional services, industrial, and special uses like schools, and gyms.
- Evolution of tenant credit: As noted above, for decades, the in-demand NNN retail product was national credit, such as Walgreens, CVS, Taco Bell, Carl’s Jr., McDonalds, or Starbucks. That has now evolved into its use within regional credit — on the retail side, think names such as Filiberto’s, Garcia’s, Serrano’s, and Oregano’s.
- Local sale-leasebacks: On a local level, sale-leasebacks have carried into physician practices on the medical side and local industrial businesses, and local restaurateurs.
- Migration from California: The NNN trend has also benefited from businesses and investors migrating out of California, allowing them to exit certain asset classes in the Golden State into sectors that offer more upside in Arizona NNN properties.
- Expanding investor base: The types of investors interested in such deals have also expanded along the way. Even private and smaller family investors have become more active in the Valley’s NNN scene.
What Does NNN Mean in Office and Industrial Spaces?
In the current environment, sale-leasebacks are particularly useful for office and industrial business owners, allowing them to free up capital for reinvestment and reduce risk.
Industrial NNN and Office Trends
Beyond retail NNN, industrial and office properties warrant specific mention. For industrial assets and real estate for lease in Phoenix, sales volume in 2024 reached $4.27 billion. Because of soaring industrial demand, investors need to be aware that many industrial properties are currently overpriced, which includes paying a premium for a triple net industrial building.
In the office sector, office space for rent in Phoenix like medical buildings are in high demand, but the overall trend comes down to investors wanting to be in Arizona. Any local businesses or regional businesses that are located in Arizona — law offices, accounting offices, contractors — may be viewed as an opportunity for a NNN structure.
How do you Evaluate a NNN Lease?
Although triple net lease deals are generally a win-win transaction, it’s important to be aware of the risks as well as the rewards:
For the Sale-Leaseback Seller
The primary consideration is relinquishing ownership of the property. This means potentially missing out on future appreciation and residual value. However, this can be a worthwhile trade-off if the capital unlocked from the sale-leaseback.
For the Investor
The main risk comes primarily from the tenant’s nonperformance. In these types of transactions, it is paramount to vet the tenant to ensure they will be in business for the duration of the lease and beyond. This can be mitigated by acquiring an asset with multiple exit strategies, but the most important protection comes from performing the proper financial analysis and due diligence.
Key Considerations for NNN Deals
Beyond the significant premium for a national brand within NNN properties in Arizona, there are several issues to be aware of.
First and foremost, a franchisee represents more risk than corporate owners, for financial reasons among others. Second is to be alert to lease structure. For example, a deal may be portrayed as a triple net long-term lease, but if a tenant has a right to terminate early, that is not a true 30-year lease — effectively, it might be only five. And third, there may be other hidden loopholes that increase liability. For example, a tenant is responsible for taking care of taxes, insurance, and maintenance, but they’ve carved off certain structural repairs, such as the roof, parking, or systems like plumbing or HVAC.
NNN deals have certain commonalities. Vetting a prospective tenant is very important across any and all asset classes, whether it’s a sale-leaseback or a general triple net lease for an investor. Here are a few of the financial elements to take into consideration:
- Particularly with local credit or regional credit, you want to make sure you have good guarantees in place. A big business is likely to have a more established track record than a startup.
- Knowing and understanding the business is non-negotiable, starting with at least three years of financials. Can they afford this rent? Is it similar to what they were paying before? What does their EBITA look like?
- Do they have a good story to tell, and look like they are going to be in business for the long haul? No matter what asset class you’re looking at — retail, office, industrial, or nonprofit — you want to be confident about what makes them viable now and 20, 30, or 40 years from now beyond the term of the lease, because that will be important if you have to sell the property. If you have a 10-year lease and want to sell in year 6, an investor will want to know if the tenant is financially solid.
- Is their business recession-proof and inflation-resistant? If their revenues have fluctuated over the years, you want to understand when and why. Value fluctuation is a significant risk for NNN investors, and you want to ensure you’re making a deal with a steady Eddie, not cyclically tied to a business that will struggle making its payments when economic pressures arise.
Strategies for Successful NNN Property Investing
NNN properties offer stable income and diversification, but success requires careful planning. Prioritize tenant creditworthiness by scrutinizing financials and industry outlook. The lease term is crucial — longer leases offer stability, while shorter ones provide flexibility. Location impacts tenant success and property value, so consider demographics and accessibility.
Due diligence is essential. Conduct a thorough financial analysis, review the lease for loopholes, and inspect the property. Manage risk by diversifying across properties and building a reserve fund. Finally, working with experienced real estate professionals can provide invaluable guidance.
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Could a Sale-Leaseback Be the Right Move for Your Portfolio?
Whether you want to raise capital from a property you own or are interested in NNN properties in Arizona, the team at R.O.I. Properties is ready to help you formulate a sale-leaseback and/or NNN strategy that aligns perfectly with your business goals. Explore triple net lease opportunities today. For more information on NNN properties in Arizona, contact us today at [email protected] or 602-319-1326.
