We’ve all heard the old adage about the three most important aspects of Real Estate being Location, Location, Location.
I would venture to say that the three most important elements in Triple Net Lease Real Estate are Lease, Tenant, Location. You see it’s the Lease that dictates the cash flow. And it’s the Cash Flow that determines the Value.
Let me explain: When it comes to Triple Net Lease Investments it’s the cash flow from the property, the length of the remaining term on the lease, and the creditworthiness of the tenant that mainly determines the value. Value in Triple Net Lease Real Estate all revolves around risk.
The shorter the remaining term on the lease, the greater the risk that your tenant may not renew, move out and your location goes dark. The weaker the tenant is financially increases the risk that they may not be able to pay your rent. This greater degree of risk is reflected in a higher CAP Rate or cash flow. If the property has more risk, it will have a higher Cap Rate in order to make it more enticing for someone to buy.
An example of this would be a 20 year remaining term CVS at a 5.25% Cap Rate. Great credit in CVS along with a long term lease. Compare that to Joe’s Diner on the corner. Same 20 year lease, but the owner would be assuming a much greater Credit Risk in Joe’s financials as opposed to CVS’s balance sheet. So Joe’s Cap Rate might have to be 10+% because of the greater credit risk in Joe’s Financial Statement.
Let’s get a working definition of a Triple Net Lease:
A Lease Agreement on a property where the tenant agrees to pay all real estate Taxes, Building Insurance and Maintenance on the property in addition to any normal fees that are expected under the lease (such as Rent, Utilities, etc.)
The first question you ought to be asking is “who is responsible for meeting the terms spelled out in the lease”? The short answer is that the balance sheet of the tenant and not the owner of the property guarantees the payment of rent.
Follow this example:
Let’s say that one of these Triple Net Lease properties (could be a Drug Store, Auto Supply Store, Dollar Store, Fast Food Restaurant, Convenience Store, Bank, HealthCare, Nursing Home…you get the picture) is on the corner of Main and Main in your quiet little town.
First that Drug store on Main Street is not owned by the Drug Store Company. It’s more than likely owned by an individual who leases it back to the Drug Store company, and for that, that owner of the building receives Rent.
And the payment of that rent is contractually guaranteed (under the lease) to be paid by the Full Faith & Credit of the parent company.
So it’s not the store on the corner of Main & Main that is guaranteeing to make the rent. It’s the Parent Company of the Store on the corner of Main & Main that promises to make the rent payments.
In a Corporate Triple Net Lease, the rent is contractually guaranteed by the Parent Company’s Balance Sheet (ie Parent Company’s Net Worth).
In other words, the rent is backed by the Parent Company of the Drug Store, Auto Supply Store, Dollar Store, Fast Food Restaurant, Bank, Convenience Store, HealthCare, Nursing Home etc.
OK. So Now we’ve got a big maybe Public Company with very deep pockets backing up the obligation to pay the rent on these Triple Net Lease Stores.
And if the remaining term on the lease is 20 years, then the Parent Company guarantees to pay your rent according to the Lease Contract for the next 20 years. That’s why you want to be comfortable with the tenant’s financial ability to take care of your property, pay all the bills and send you a rent check each and every month for the next 20 years, or until you decide to sell your property to the next owner.