Triple play

by Kirill Perelyguine 30 Mar 2020

Choosing to add another property to your investment portfolio requires taking several factors into consideration, including financial security, liquidity and long-term stability. Many of these aspects come together in an often-overlooked type of commercial investment: the single-tenant triple net property. Think of a single-tenant retail property in a freestanding one-story building occupied by Famous Burger Place, Ubiquitous Coffee Shop or Furniture Store That Makes You Build Your Own Tables. In some cases, this type of property is owned by the tenant; however, there are plenty of opportunities for an investor to own such a property as part of a balanced portfolio.

This type of investment property could be a perfect fit for several types of investors: low risk-oriented, those looking for hands-off investments, those looking for stable and long-term income flow or even those just starting out in commercial property investment. Let’s take a look at what makes triple net investment properties so attractive for the investor looking to have as little involvement as possible.

Lease is more
Commercial leases offer a number of benefits for investors. First, a triple net commercial lease agreement means that the tenant is responsible for their proportionate amount of the property tax, maintenance and insurance, and sometimes even the major structural repairs to the property. In the case of a single-tenant property, the tenant usually pays for all of the associated costs, leaving the landlord with the ‘clean’ net amount of rent, which makes it much easier to calculate cash flow and make long-term financial projections.

Second, the length of the lease is usually quite long, often 10 to 20 years, with an option to renew for another 10 to 20. The length of the lease plays into the tenant’s interest in establishing their presence in a certain neighbourhood and securing it for years to come. From the investor’s perspective, taking vacancy out of the pro-forma means adding a couple of dollars to the net operating income.

Additionally, the tenant profile of a solid corporate franchise usually allows for more favourable terms when it comes to financing, as the lending industry views these tenants as a lower risk, thus allowing some breathing room for the mortgagee.

One strategy to try when buying such a property with a financial institution as a tenant is to approach the tenant for the financing. This can serve as a litmus test: If a lease renewal is coming up in several years, and the bank refuses to finance the property that they themselves are occupying, that might indicated that the bank is planning to leave this location at the lease renewal, making the investment not that great overall. If the bank does provide the financing, you have a chance of negotiating a lower-than-market rate on your mortgage and enjoying a higher return than initially planned.

What to watch out for
All of the above factors make a triple net-tenanted commercial property seem like the jewel of any investor’s portfolio. However, there can still be a few wrinkles in this shiny, picture-perfect property-tenant combo that you should take into consideration before engaging in such a play.

In terms of the lease for the property, keep in mind that a large corporation doesn’t do anything without its own legal department in tow, so it’s important to get a lawyer’s help during due diligence investigations and contract preparation, as items such as roof repair or parking lot repaving may or may not be included in the lease agreement. The balancing act between a landlord looking to maximize the net stream of income and a tenant trying hard to minimize its responsibilities under the lease agreement needs to be investigated thoroughly.

Secondly, given the relative security of the investment, these properties tend to sell at a lower cap rate, and thus higher prices, than other similarly performing investment properties.

Finally, even though the ideal situation looks like a lazy, management-free arrangement in which the tenant is responsible for the maintenance of the property (and should ideally be using a professional property management company), you’ll still need to monitor the quality of maintenance to avoid neglect by the tenant and property manager. The landlord is usually responsible for structural elements of the building, such as the roof, HVAC and foundation, and neglect of the A/C system by the tenant could cause a major expenditure ahead of a scheduled replacement.

As with any type of investment, there are pros and cons associated with triple net investment properties. However, if approached with caution, the benefits of this type of investment often strongly outweigh the negative aspects in the long run.

Triple net investments: Pros and cons

Pros Cons

Inflation protection through stable long-term income

Limited upside, unless there’s potential for future development

No vacancies for a long time

Risk of complete vacancy after lease completion

No owner responsibilities

Risk of poor maintenance by the tenant

Property can be sold with the lease

Lower cap rate at purchase

Professionally managed property

High capital expenses after vacancy

 

Kirill Perelyguine is a broker with Royal LePage Real Estate Services in Toronto, specializing in commercial investment properties and land development. Contact him at [email protected], or visit investingontario.com.

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