Triple Net Leases (known as NNN) continue to be a sought-after commercial asset class for many investors.
By Al DiNicola, AIF®, CEPA ™
February 4 , 2023
DST 1031 Specialist
NAMCOA® – Naples Asset Management Company®, LLC
Securities offered through MSC-BD, LLC
The agreement used in a NNN lease specifically spells out what the owner of the property provides and the responsibilities of the tenant. Typically, in a NNN the tenant is responsible for all expenses associated with the property including operating expenses, insurance, as well as taxes on the property. The owner of the property has little management responsibility for the property. Items such as the roof and other major items may be negotiated. By comparison a standard commercial lease typically insurance and taxes are paid by the investor/landlord. There are single net leases where the tenant pays property taxes and in a double net lease the tenant pays for property taxes and property insurance.
Triple Net leases may be use for a variety of tenants in many commercial asset classes. Typically retail, manufacturing and other service businesses enter into triple net leases. Credit tenant would include Take 5 Oil Change, Advanced Auto Parts, Walmart neighborhood stores, CVS, and other national tenants. There are benefits entering into lease with a national tenant. All real estate has risks involved and NNN are no different.
In smaller strip centers if the main tenant gets in financial trouble, defaults on their business loans and cannot make their rent payments, the landlord may be faced with a big decision. There have been national tenants closing their doors or even filing chapter 11 or 7 (bankruptcy). If the anchor tenant goes down there may be difficulty filling a specific space.
On the positive side a triple net offers a steady and consistent revenue stream. The investor expects to have limited management involvement since the tenant is normally responsible for utility expenses, repair costs, taxes, and any property management costs and issues. The investor or landlord is free to focus on other business opportunities.
Triple net leases tend to have lower rents because the tenant assumes ongoing expenses that would otherwise be the responsibility of the property owner.
Triple net leased properties have become popular investment vehicles for investors because they provide low-risk, steady income.
The management free aspect of the NNN for investors have been the main reason for investing into this specific asset class. Many baby boomer investors who have investment real estate are seeking a solution where a passive investment may be in their future. There are also other investors seeking an easier way to get into a passive real estate investment for a number of reason. For the most part the NNN properties seem to be a solution. But there are still a variety of risks. There has been a tremendous amount of investors moving out of traditional NNN as well as other asset classes and investing in Delaware Statutory Trust (DST).
The Delaware Statutory Trust (DST) structure embraces all the synergies of the NNN with multiple additional benefits. The DST structure operates as a passive investment where the investors have no management responsibilities. The DST structure also includes a master tenant who handles all the management of the property. The properties included in this structure include multiple asset classes. Having a variety of asset classes provides the investors with asset class diversification. There is also geographic diversification where an investor may invest in several properties in a variety of locations and even states.
Understanding a Delaware Statutory Trust
Investors typically invest in traditional deeded real estate. Prior to DSTs being approved as a qualifying replacement asset for a 1031 exchange by the IRS, investors were faced with limited strategic solution. A DST represents a beneficial interest in a trust. The Trust (Delaware Statutory) owns the real property. One of the advantages of a DST structure is the method of how the property is held. The DST property may be a single asset or property such as a 275 unit apartment complex in Texas. Alternatively, the DST may own a portfolio of 18 necessary retail properties (Walgreen, Tractor Supply, and grocery stores for example) that are located in nine states. The typical minimum investment for a 1031 exchange into a DST is $100,000. The other advantage is the ability to purchase the exact amount of your replacement property to avoid any “boot”. For example, if you sold a property (once again the relinquished property) for $524,750.90 you can specify that amount in a DST (based on availability).
Managing Risk through Diversification
Congratulations you have successfully sold your NNN investment property. Now what do you do? Do you simply move all the proceeds into another property? You may cautiously place all your proceeds into one property. You may also wonder if you acquire more than one property easily and without jeopardizing your exchange. The previous mentioned stress of the 45-day identification period locating one property not to mention more than one property compounds the stress. However, a potential (and proven) strategy may be the utilization of multiple DST properties. There may be NNN DST properties as well as other DST asset that perform as NNN properties. Many financial advisors would suggest not placing all your eggs in one basket.
Diversification seeks to spread risk out to more than one asset class or in the case of DST different geographic allocations. There is risk in all investment strategies. We always suggest investors review their real estate portfolios and consult with their CPAs on the depreciation schedules of their properties. CPAs may be aware of the advantages of the 1031 exchange process but there are a limited number of CPAs who have the experience in dealing with DST for a number of reasons. Real Estate attorneys may also be familiar with the 1031 exchange process, however, like the CPAs may have limited experience with the DSTs. We always welcome calls from your CPA or attorney to provide detailed information on the DST solution.
Dealing with Inflation
The benefit for the person leasing the NNN space is the minimal rent increases that occur over the term of the lease. In evaluating a commercial property typically there is a cap rate assigned to the Net Operating Income (NOI) that determines the value of the property. Many of the national tenants enter into long term leases that may extend 20 years plus. There may be very small rent bumps in the agreement that may be eroded with inflation over time.
So how does a DST deal with inflation?
Many DSTs will have a shorter lease term than the typical NNN. The packaging of the DST with passive income and no investor responsibility may be considered operating similar to a NNN. In effect other asset classes such as multifamily apartments, student housing, self-storage and others create opportunity for rents to be reset on an annual basis or in some cases shorter period of time. This enables the DST to respond to the market.
Quick Delivery and Response for Investors
The cash investors are typically at an advantage when purchasing a DST. The cash investors are ready. The 1031 Investors still have the ability to “strike quickly” when they have completed the sale of their relinquished property and their proceeds are sitting at the Qualified Intermediary (QI). DST have been referenced as being packages. Packaged from the standpoint of offering documents called Private Placement Memorandums(PPM) already completed as well as being structured with or without a debt component. Many 1031 exchangers may be seeking debt replacement and DST debt is non-recourse to the investors. The quick delivery means that if the 1031 exchange investor is pressed to the end of their 45-day identification period they may still be able to identify a few solutions and save their exchange.
What can go wrong may go wrong.
Once a 1031 exchange investor has identified a traditional replacement property there may be a host of issues to keep a keen eye on so that your exchange will not fall apart. Inspections, approvals for financing, closing contingencies all need to be tied up within the 45-days to provide additional comfort for the investors.
NAMCOA can provide a starting point.
Typically, we would engage an investor with just a few simple questions. Have you spoken with your CPA to determine your potential capital gains. In some cases, the 1031 exchange options may not be the best solution. However, we can shed light on the entire 1031 exchange process since we deal with exchanges all the time. As mentioned previously CPAs and attorneys may not handle 1031 exchanges as a common practice. Please let us know how we can assist you through education, understanding and creating a exit strategy.
DSTs are not for all investors. The acquisition of a DST is for accredited investors only. Contact your investment adviser for additional details on how a DST may be a solution to your 1031 Exchange and suited for your investment future. For more information on how to properly set up an IRC 1031Tax Deferred Exchange or if you are an accredited investor and would like additional information on a DST contact Al DiNicola at 239-691-8098 or email firstname.lastname@example.org.
This is not an offer to purchase or solicitation to purchase any security, as such be made only through an offering memorandum or prospectus. Investing in securities, real estate, or any investment, whether public or private, involves risk, including but not limited to the potential of losing some or all of your investment dollars when you invest in securities. You should review any planned financial transactions that may have tax or legal implications with your personal tax or legal advisor. NAMCOA, LLC is a Registered Investment Advisor, regulated by SEC (Securities and Exchange Commission). Our corporate office is located at 999 Vanderbilt Beach Road, Suite 200, Naples Florida 34108. Securities Offered through MSC-BD, LLC, Member of FINRA/SIPC. 8215 SW Tualatin- Sherwood Rd, Suite 200, Tualatin, OR 97062. MSC-BD, LLC and NAMCOA are independently owned and are not affiliated.
NAMCOA® – Naples Asset Management Company®, LLC