Investing in commercial real estate is a great way to generate wealth producing relatively consistent returns through monthly income or capital growth

Real estate returns are generated in two ways: income return and capital returns. The income returns comes from tenants’ rent payments and the cash that remains after all property expenses have been paid. Capital returns are the increase or decrease in the value of the property due to changes in market demand and/or inflation.

The first steps to investing in commercial real estate is to ask yourself why you want to invest in real estate and to define what type of investor you want to be. What kinds of returns are important to you?

An investor that is interested in income return, or stable cash flow, purchases a property that can provide a monthly income. The income return from real estate is directly linked to the rent payments received from tenants, minus the costs of operating the property and outgoing mortgage/financing payments. Analyzing this type of property has been likened to the analysis you may do if you were to buy a business. This means thoroughly examining the financial records of the property to prove it could stand on is own each month. Also important is the property’s ability to stay leased so that these financials remain.

When investing in a single-tenant office or industrial building this may mean you evaluate the current tenant more completely to be sure they intend to and can afford to continue leasing the building. For a multi-unit property, the strength of the leasing market and competitive rates of the property are more important.

One of our clients that favors triple-net investments recently reviewed the real estate deals he had participated in over the past couple of years. He found he was getting 9.4% return on cash and pointed out that the internal rate of return was even greater in that you are also reducing debt.

Unlike cash-flow investors, long-term or “hold” investors rely on capital returns through real estate appreciation to build their wealth. Capital appreciation of a property is determined by whether or not your property would sell for more than you bought it for. If so, then you’ve achieved a positive capital return. These investors rely on the simple strategy of patience. They look for real estate that will appreciate over time because of location, market changes, or inflation, or deals that provide an upside by offering the ability to increase cash flow or update the property.

The capital return is more difficult to calculate, and requires the property to be valued or appraised. The majority of the volatility in real estate returns comes from the capital appreciation component of returns. Income returns tend to be fairly stable. Capital returns fluctuate more and although this tactic can be riskier, many times the return is greater.

While you are out in your city, start looking at the real estate you see – from the retail center at the corner to the industrial building by your office to the vacant land by your house. Is the shopping center fully leased? What kinds of tenants occupy the buildings? An investor owns every one of these commercial properties.

• Clayco Academy purchases site of new Baytown Academy Sports, Houston Business Journal
• Two Clay & Co Execs Awarded CCIM Designation, REDNews
• The newest Houston-area Academy Sports + Outdoors store, at 6425 Garth Road, has a new landlord, Houston Chronicle
• The Deal Sheet, Real Estate Bisnow

If you could have an investment that paid you regularly with limited management, would that excite you?

If so, the long-term triple-net-leased property to a sound company with good financials (and maybe even personal guaranties or letters of credit) may be an investment for you.

One of the exciting components of a triple-net investment is that the tenant is the one who maintains the property and typically pays all of the building’s expenses. You, as the owner, receive your rent. Should you have any debt service on the building, this rental income goes to pay that expense. The balance is for you.

Let’s look at what’s currently happening in the market. Cap rates seem to be stable, or possibly shifting downward slightly, on most types of properties. Some of the lowest cap rates are apartments, followed by central-business-district office projects, R&D industrial, neighborhood retail and industrial properties. Some of the favorite triple-net properties are, not surprisingly, those that seem to offer the least risk – such as Wal-Mart, McDonald’s, Lowe’s, Walgreens and other high-profile tenants. Should an investor be looking for a higher return on their investment, they should probably look at lesser known, yet well capitalized companies.

While long-term triple-net investments provide stability and income, there is a downside. Your assets are locked into a long-term lease, and you’ll miss out on chances to capture any gains in rental income when fundamentals improve.

But there still seems to be a strong supply of debt available due to long-term leases to credit tenants, a trend strengthened by the ease of underwriting for single-tenant properties. We are still seeing institutional investors, REITs and foreign buyers, as well as private investors, investing in all-cash transactions; currently, they have nowhere else to put their money and achieve a decent return.

So, investors looking for limited management responsibilities, longer-term leases with a stable cash flow and the unique tax benefits from real estate, a triple-net investment may be the right play.

Clay & Co Note: See a recent example of this type of investment here or read more triple-net leased investments articles.

Looking for a rock-solid investment in a shifting economy?

Look no further than single-tenant net-leased properties. In markets where shopping centers sit empty and office buildings are dark, the lights are on (usually 24 hours) at the corner drugstore — provided it’s a Walgreens or a CVS. With their invest- ment-grade credit ratings and penchant for long-term leases, these drugstore triple net- leased deals attract top dollar in almost every market.

But drugstores are only one of a stable of creditworthy tenants for net-leased deals, according to a recent anecdotal survey of CCIMs. Other tenants are also attracting buyers. CCIMs report that everyone from all-cash individual buyers in small towns to big-city real estate investment trusts are looking to add one, two, or 20 of these stable investments to their portfolios.

Supply/Demand
From every U.S. region, CCIMs report that the NNN supply is tight and the demand is high. “The entire state of California has more money than product,” says George L. Renz, CCIM, of Renz & Renz in Gilroy, Calif. He has the investors: His big- gest challenge is finding deals with good intrinsic value that “truly reflect safety and truly reflect investor’s goals — most of which involve risk avoidance.” In Atlanta, “I am seeing more out-of-town buyers from everywhere in the country and even international,” says Virginia I. Wright, CCIM, vice president of net-leased invest- ments for Bull Realty. “With a strong lease, tenant, and location, they are satisfied without having to visit the property and just enjoy the rent checks. Many buyers would love portfolios of properties; however, these are more difficult to come by.”

Many of those portfolios are going to institutional investors that have turned their attention to net-leased product in the past few years. REITs, insurance companies, and pension funds have contacted CCIM brokers in smaller markets this year, looking for portfolio deals.

Money Is Available
One reason for the interest in net-leased deals is that financing is available at alllevels. With most net-leased properties priced under $5 million, many single-asset purchasers buy with cash, according to the CCIM market round-up. “We have been doing transactions almost always with knowledgeable all-cash buyers who want to close swifly,” says Rob Murdocca, CCIM, of Prescient Property Group in Wayne, Pa. Len S. Jarrott, CCIM, of Jarrott & Co. in Santa Barbara, Calif., has completed three portfolio deals ranging in price from $9 million to $32 million — all 1031 deals that closed with cash. “When I do use debt, I go to life companies,” he says.

Wright adds that a variety of financing sources are available for investors who want leverage, and CCIMs in most markets con- firm this.

“Smaller investment deals are getting financed through smaller, extremely well-capitalized rural banks flush with farmers’ cash,” says Shad J. Phipps, CCIM, a senior associate with CB Richard Ellis in Columbus, Ohio.

“Very desirable rates, usually in the 60 percent loan-to-value range, can be found for qualified buyers with qualified properties,” says Chris Schreiber, CCIM, an associate broker with Kiemle & Hagood Co. in Coeur d’Alene, Idaho.

NNN Challenges
Despite the availability of money for NNN properties, financing is still a concern, given that most local banks require pre-existing relationships. “All of the smaller community banks require that a borrower has an estab- lished track record of working with them,” says Casey Weiss, CCIM, of Access Com- mercial Real Estate in LaCrosse, Wis. Tey also ofen limit their loans to the local area, he adds.

Another problem is conflicting buyer and seller timelines, Murdocca says. “Sellers need to be prepared to meet buyers’ need for due diligence. Triple-net deals sell well, but buyers still want a feasibility period.”

While lack of supply is a problem in almost every market, a hidden niche may be older net-leased properties, Weiss says. “Investors seem to be more interested in NNN proper- ties that have some age, versus brand-new NNN properties,” he says. “Older NNN properties have a lower per-square-foot price, which means that they don’t require as high of lease rates if they are forced to release.”

In today’s market, he adds, “Investors are putting more emphasis on their back-up plans. They realize that losing a tenant is a real possibility, and buying older properties can help them prepare.”

Even with newly developed NNN properties, investors are not taking as many chances, says Gregg H. Tompson, CCIM, general manager of Ratcliff Facilities, in Alexandria, La. Ratcliff specializes in developing NNN properties, recently for Dollar General. “Since there is no such thing as ‘too big to fail’ anymore, investors are exploring options and worst-case scenarios with their properties,” he says. “We are seeing this hedging early in the negotiating phase of our completed development projects.”

Thompson is also concerned about upcoming FASB changes. “As a developer, we feel that these proposed changes will dec- imate the design-build net-leased market by forcing tenants into shorter lease terms or to revert back to fee-simple ownership of properties. Tis will dramatically decrease the attractiveness of commercial real estate as an investment due to increased manage- ment and risk associated with properties.”

Clay & Co recently created a $25M investment partnership, with plans to buy $64M worth of assets in the Texas Triangle. It’s the first fund created by the Houston-based firm best known for holding large, multi-property auctions. We snapped president Tim Clay between Kevin Dalrymple and Amy Silvey, who tell us they’re forming the “Texas Triple Net Real Estate Partnership” to acquire income-producing properties that are triple-net leased to strong credit tenants. Other requirements: Location is important (as is location and location); all assets must be single-tenant with at least a five-year remaining lease term; and returns must be double-digit. Tim would like an even spread between office, retail, and industrial properties, but is seeing more opportunities in the industrial sector.

Tim tells us Clay’s launching the fund now to capitalize on ideal interest and cap rates. Plus, it can get leverage returns of 13% or higher (its last purchase brought in 16%). Tim says he plans to hold the properties for five to seven years. Clay’s most recent buy was the Water and Power Technologies’ 20k SF warehouse (pictured). Tim says the facility has 10k SF of expansion capabilities, and he liked the lease (10 years), location (near the port), and tenant’s industry (water purification). Clay has contracts out for its first fund purchases.

See the complete edition here.

Below is a summarization of an article on net-lease investments in the most recent issue of Globe St.’s Real Estate Forum titled “Long Term Rules in a Short-Fused Market”

• For some investors, net lease investment’s income potential scores over short-term capital gains other asset classes offer.
• Investors looking for quality net-leased properties won’t find them at distress-sale prices.
• However, the customary attributes of this niche sector – stability, predictable cash flow and low operating costs – combined with higher cap rates and more readily available financing make the long-term potential attractive.
• Net-lease investments provide a “conservative, low-risk way to invest” providing “good long-term income characteristics” versus short-term capital gains.
• Currently the market is showing net-leased investments separated up into three segments: properties that are well-located with highly-rated, investment grade tenants; properties with the aforementioned attributes as well as assumable debt; and properties with non-credit tenants.
• Choosing the right property is a balancing act between the tenant’s credit, the quality of the asset, and the structure and duration of the lease.
• When considering the real estate, many investors look for something that’s generic and multi-functional across several asset classes.
• “The first markets to get financing will be those that have the highest quality real estate and predictable cash flows…and that applies to the higher-rated net lease properties.”

Full article at GlobeSt.com’s Real Estate Forum

Although much of our advice comes from being brokers for 25 years, we can also provide first-hand knowledge as buyers ourselves. As buyers we are narrowing in on long-term, triple-net leased investments for our portfolio.

A triple-net lease holds the tenant responsible for rent as well as all property operating expenses including taxes, insurance and maintenance. This type of lease is favored by investors – including ourselves – because the landlord’s responsibilities are significantly reduced. Triple-net-leased investments are a good alternative for providing cash flow while surrendering the responsibilities of management and maintenance. When evaluating this type of deal, it is important to look closely at the tenant and assess their current and future financial strength in order to be assured of the tenant’s ability to meet the terms of the lease.

The analysis of a net-leased investment concentrates much more heavily on the lease rather than the building and land. However, it is still important to assess the physical real estate as you would in any transaction. A strong location, land size, quality construction, replacement costs, and the ability to re-lease the real estate are essential factors to consider.

Many investors use a capitalization rate to determine the value of an investment. Although it should not be the only measure of an investment, capitalization rate is a simple formula that calculates the ratio between the purchase price and the net operating income. By dividing the purchase price into the net operating income you arrive at a capitalization rate that will help you determine value relative to similar properties.

Each individual should be sure that a triple-net investment meets the specific goals of the investor. Complete due diligence, establishing financing, and understanding any tax benefits are all critical before committing to any long-term investment. But with proper understanding of some critical components – type and length of lease, tenant strength, the physical real estate/location, and cap rate – an investor can be sure that a long-term triple-net leased deal is a sound investment.

Contact us for more information on this and other types of real estate investing.