Net Lease Investments

Net Lease Investments

The fascination of “No Management” has bombarded the Sunshine State

Triple Net Lease Investments, the phenomenon that allows a landlord to defer all of the owners’ traditional responsibilities to a tenant, has taken over as an investment of choice for both private investors and institutional buyers.  By having all management/maintenance, taxes and insurance, (hence the three (3) nets) taken away from a landlord’s daily tasks and given directly to the tenant to handle, allows for the most passive form of real estate investment for a sole owner in today’s market.  Most net lease assets fall into a few categories; office, industrial or retail buildings. 

Retail transactions make up the bulk of net lease investments.  The drug store on the corner, restaurants along the busy street and bank branches in front of the new supermarket are all some of the most popular investments.  But exactly what is one purchasing when the decision is made to become a passive real estate investor?  With net leased properties, three considerations, in this specific order, must be analyzed before an investment is procured; the intrinsic value of the real estate, the tenant’s credit and the lease terms.  First, the real estate or the location of the property.  We cannot forget that we are still investing in real estate.  The cliché adage of “location, location, location” does not go away just because there is income attached to a property.   Even large, public companies go out of business.  We’ve seen many examples in recent years.  Therefore, we have to understand the value of the property without a tenant and the feasibility of attaining a new tenant if the current rent-payer decides to leave at any point.  Next, the actual tenant that is in place for a particular property may dictate the value of that property.  The difference between a high Standard & Poors (S&P) rated company as a tenant and a local “Mom and Pop” operator is usually vast.  Meaning the probability that the S&P rated company defaulting on their lease is lower and therefore a landlord can be more assured of receiving their rent from that tenant for a longer period.  Conversely, if the Mom and Pop operator had a couple of bad months, they could close indefinitely.  Lastly, the terms of the lease are important to an investor.  The most sought after leases are absolutely passive to the landlord where, in most cases, they receive a wire transfer from the tenant each month and never so much as receive a phone call about the property.  There are many variations on net leases, but those with the most passivity garner the lowest returns because there is little to no work involved for the landlord.  Blending the three aforementioned attributes is the most specific means in determining the value of a property.

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When buyers and sellers are determining the specific value of their net lease investment, they typical use capitalization rates, or cap rates.  Simply dividing the net rent into the purchase price will determine a yield for the investor.  The higher the cap rate the lower the price but the perceived risk for the property is higher and vice versa.  Over the past several years, cap rates have dropped significantly given the fact that several driving forces were at all time highs, or lows, depending on how you look at them.  For instance, interest rates were very low allowing prices to increase due to the availability of debt.  Additionally, cap rates were affected by the influx of investors completing 1031 exchanges.  While people were selling their properties for record prices, they were motivated to not pay their long-term capital gains taxes and use the IRS code to purchase another property.  With a tremendous amount of investors using the tax code to their benefit, all at the same time, the demand for passive, income producing properties (net lease investments) increased dramatically.  Now, Real Capital Analytics recently reported that all retail cap rates have been gradually increasing since the third quarter of 2007 by roughly 25 basis points.  Additionally, of the five major Florida markets; Jacksonville, Miami, Orlando, Palm Beach and Tampa, industrial property activity remained somewhat flat over the last several months.  Office property pricing dropped slightly in the last three quarters, increasing cap rates to levels not seen for the last eighteen months.  While volume is down for all three asset classes, there has not been a drastic change in pricing since the alteration of the debt markets.

For the last several years, brokers who focus their practices strictly on net lease properties have had some banner results.  However, now that the market is tightening, sellers are flocking to their trusted sources for honest and frank information on today’s market perceptions.  The real estate professional that has a fiduciary duty to their client is now sought out by many sophisticated and savvy owners.  It is fiscally irresponsible for a developer or investor to pursue a property if they don’t have a clear and quantifiable exit strategy.  Those that are in the market everyday and focus on net lease investments are a sought after commodity because “the tide will no longer float every boat.”  Realistic assumptions need to be made for the seller who is investing in this market.  Buyers are also seeking the advice of specialized brokers who see opportunity in the market and want representation from an expert.  Having a broker who is committed to sorting through the varied options in today’s market will only benefit the buyer to show them the overall advantages of one property over another.  This is especially helpful with buyer’s completing 1031 exchanges in the aggressive timing parameters.

Overall, the Florida net lease investment market has shown significantly strong signs of maintaining its vibrancy.  When investors and debt sources begin to take a closer look at each investment, the investors usually go back to tried and true philosophies.  Florida is seen as a market that is still attracting a growing population and developers will need to support that growth by accommodating tenants with office, industrial and retail buildings.  In today’s market, tremendous value is being placed on the assets that are in more dense areas with strong tenancy and long, passive leases.  Markets that were once seen as speculative or “in the path of growth” are now not in the forefront of investors’ minds, but still remain an interest for future investment.  We must also not forget that a large percentage of investors benefit from the Florida’s lack of state income tax.  Investments in the state will always get more interest due to that one simple fact. 

David Sobelman is Executive Vice President of Calkain Companies.  Calkain is the only brokerage firm in Florida strictly focused on net leased income producing properties.