Join a couple of our Kay Properties Delaware Statutory Trust experts Betty Friant, Executive Vice President and Matt McFarland, Senior Vice President as they unpack the nuances of triple net lease properties.
Triple net real estate investment properties are a popular choice for 1031 exchanges. Kay Properties Executive Vice President and Managing Director Betty Friant and Senior Vice President Matt McFarland take a closer look at NNN properties, and how they fit into the Delaware Statutory Trust space.
One of the popular asset classes for 1031 exchanges is the single tenant net leased property. Many investors are attracted to these assets because they are perceived as passive investments. However, there is more management responsibilities than many investors think, and putting all your eggs in one basket might expose investors to over-concentration.
- (07:47): What is a triple net lease property? (Link to Transcript)
- (11:24): What are some of the potential attractions of investing in a single-tenant net lease property? (Link to Transcript)
- (19:36): What are some of the potential pitfalls of investing in a single tenant net lease property? (Link to Transcript)
- (24:47): Passive ways to invest in single triple net or a single-tent net lease properties (Link to Transcript)
- (28:24): Closing risks involved in independently purchasing a net lease property. (Link to Transcript)
Nick Snyder:
Hello everyone. Thank you for joining us for our Kay Properties 1031 Exchange DST Investor Conference call hosted by Senior Vice President Matthew McFarland. Today we will begin with the risks and disclosures.
DST 1031 properties are only available to accredited investors, generally described as having a net worth of over $1 million exclusive primary residence and accredited entities only generally described as an entity owned entirely by accredited investors and/or an entity with gross assets of over $5 million. If you're unsure, if you're an accredited entity and/or accredited investor, please verify with your CPA or attorney.
You may be required to verify your status as an accredited investor. The information herein has been prepared for educational purposes only and does not constitute an offer to purchase securities, DST properties and/or real estate. Such offers are only to be made through private placement memorandums which are solely available to accredited investors and accredited entities.
IRC Section 1031, IRC Section 1033, and IRC Section 721 are complex tax concepts, therefore, you should consult with your tax and legal professional regarding your specifics of your particular situation regarding your 1031 exchange and if to an investment in real estate and DST properties is suitable for you.
The material is not to be interpreted as tax or legal advice. Please state your own tax and legal advisors for advice and guidance regarding your particular situation. There are material risks associated with investing in real estate, Delaware statutory trust properties and real estate securities including illiquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to the market and softening rental rates, general risks of owning and operating commercial and multifamily properties, short-term leases associated with multifamily properties, financing risks, potential adverse tax consequences, general economic risks, development risks, and long bold periods.
There's a risk of loss of entire investment principle. If you are foreign investor to qualify for any type of investment, there are both financial requirements and suitability requirements that must match specific objectives, goals, and risk tolerances.
The included scenarios are hypothetical and do not intend to represent any actual investors' situation or performance of investments. Your particular scenario may have other factors not mentioned here because investor situations and objectives vary. This information is not intended to indicate suitability for any particular investor.
Diversification does not guarantee profits or guarantee protection against losses. This information is from sources we believe could be reliable, however, we cannot guarantee or represent that it is accurate or complete. Past performance is not indicative of future returns, potential cash flows, returns, appreciation are not guaranteed and could be lower than anticipated.
Thank you for everybody for listening in and I'd like to turn the conference call over to Matthew McFarland with Kay Properties.
Matt McFarland (03:29):
Thank you very much Nick for the introduction and as always, thank you to all of our listeners, we really appreciate your presence here and for tuning in week in and week out. We do host this call live every Friday and have gone back probably at least a year at this point. So we really appreciate your presence here and look forward to continuing this series. This is a call that we have titled DST Essentials, and here we dig into the recurring themes and nuances, specifically with respect to the DST and 1031 exchange process.
In this series, we interviewed many members of the Kay Properties team who each bring their own unique and valuable perspectives. Perspectives that have been formed over vast transactional experience in the DST investment landscape. So I'm really excited to continue our series today, but before I bring on our guest, I want to give just a little bit of information about Kay properties.
Kay Properties is a national Delaware statutory trust investment firm. Our platform, kpi1031.com provides access to the marketplace of DSTs. This includes over 25 different sponsor companies, custom DSTs only available to Kay clients as well as, on occasion, active DST secondary market listings. Kay properties team members collectively have over 150 years worth of real estate experience, are licensed in all 50 states and have participated in excess of $30 billion worth of DST 1031 investments.
Today, I'm very excited to have Betty Friant on the call with me. Betty Friant is a managing director. Betty heads up our Washington DC office, she comes from an extensive, over 35-year background in commercial real estate and expertise in investment sales, she holds the coveted CCI designation, which recognized expertise in commercial and investment real estate.
Betty is driven by a unique passion for identifying clients' needs and helping them identify the best opportunities for their specific situation. And I can absolutely say she always puts her clients' needs first and personally, I have learned so much from her over the years that I have been with Kay Property, so really excited to have her on the call and couldn't think of anyone better to really dig into the topic that we're going to be discussing today.
We're going to be unpacking triple net properties. This is a topic that comes up frequently, especially for passive real estate investors. There's a couple different options out there in the passive realm. There's the DSTs, there's the triple nets. So what we want to do here is unpack how the triple net properties fits into the DST space, and secondly, what investors in a 1031 exchange should be thinking as they consider various passive real estate investments.
Without further ado, Betty, welcome to the call and thank you for being with us.
Betty Friant:
Thank you so much for having me. This is one of my favorite subjects because I was a triple net broker for years, so that was my bread and butter and why I got into DSTs, but I'll break that down later for you. Where do we start?
Matt McFarland:
I'm excited to hear you tell the story of your personal journey, but where I want to start is maybe just with a quick definition of terms. These various terms get thrown out frequently, but can you quickly start by defining what we mean by triple net as it relates to specific properties, and then on top of that, maybe unpack what these properties look like and we can just start there.
Betty Friant (07:47): What is a triple net lease property? (Back to Top)
That sounds good. The first question that some people say, if we really start at the very beginning, is why would a company like McDonald's or CVS or Sheetz or 7-Eleven, why would they need somebody to fund their building? Is what the question is often asked. And it's not really like that at all. What happens is a company, could be Lowe's, could be Costco, could be any company, but they don't often own their own real estate because if you think about it, if 7-Eleven had funds, which they do, their assets, they could put their money in real estate and get a nice return on their investment, but if they kept their capital and put it into product that they can turn over, they get a much higher return on their money by using their dollars in their business instead of using their dollars to own all their own real estate.
So they will often rent the properties that they're in. So as you drive down the street and see a Walgreens or a CVS or almost any other single-tenant net lease building, a building that's standalone, you're probably looking at a building that's owned by some landlord, whether it's a 1031 investor or a REIT, real estate investment trust, or an insurance company, pension fund just could be anybody, family office. What it means in the triple net language is that that tenant pays for the rent and then the taxes, insurance, and maintenance. If you are the landlord, instead of you're having to collect the rent and then pay all these other expenses, the triple nets stand for Net Of this is the money you get net of any other expenses, being the taxes, insurance, and maintenance. Sometimes there's some landlord responsibilities, but typically in a triple net property, most of those expenses are paid for by the tenant themselves. So it makes it a very easy way to own real estate and a very powerful way to build wealth.
Matt McFarland:
That's great. I really appreciate the overview there and even the context in terms of the why question, why do these companies not own their own real estate? So I really appreciate you unpacking that and defining quickly what the triple net means in a specific lease structure. I want to transition and get into a little bit more of your story as a single-tenant, triple-net-lease broker for many years you worked with a lot of investors who were looking for this type of real estate specifically. What I want to ask you is, first, what attracts investors to this type of real estate initially? And then also what were some of the potential pitfalls that you observed in your time there and how did that eventually lead to you moving to specialize more in the DSTs?
Betty Friant (11:24): What are some of the potential attractions of investing in a single-tenant net lease property? (Back to Top)
It was a natural transition, so I was working with one particular lady and she kept saying to me she had $900,000, which is a lot of money, and she wanted to buy a single-tenant net lease building so that she didn't have to have those landlord responsibilities and could not have to deal with tenants' toilets and trash and everything. So we looked and looked and tried to find something and she rightfully wasn't willing to borrow a million dollars, she was nearing retirement age. She didn't want to borrow a million dollars signed personally on that loan to buy one Dollar General, it just made no sense.
She actually cashed out, she to pay their taxes, but it made me think there must be a better way where somebody could buy a piece of a larger institutional quality property instead of having to buy the whole thing because there's just so much concentration of your wealth if you buy just one property. When I found the DST world, I thought, "Wow, this is what I want to do for my own investing. I'm also tired of being a landlord looking for something different than managing my own buildings," and I'm just eternally grateful for my at tenants over the years who have paid off the buildings that we own, but I don't want to do it anymore. So the DST was the perfect vehicle for me to be able to start selling the rental properties and buying pieces of larger properties that somebody else is managing for me.
In the DST world, what I liked was I could still buy a triple-net property. I didn't have to buy the whole darn thing and I didn't have to have so much in any one property and I could diversify. So in diversifying, it's not just owning triple net properties, it'll be owning triple net properties and also owning other properties that maybe have an income that goes up and down. The beauty of the triple-net type properties, single-tenant-net-lease type properties is that it's more of a consistent cashflow, you can look at the lease and if it's a FedEx lease or a Tractor Supply lease or Costco or Amazon lease, you can look at the lease and know what they're likely to pay because it's written right there and they signed the lease. And typically, it's a company that would have a large net worth. Typically, they have investment-grade credit rating just like S&P credit ratings. When you're looking at stocks, you can look at a company and see how likely they are to pay their rent.
So you're getting this predictable rental income from a company that is recognizable usually, and it's a long-term lease. So the goal is to not have to worry about it for very much for very long. Of course things can always go wrong with real estate, we all know that, FedEx could go bankrupt and then the sponsor company would have to find a new tenant for that warehouse or a distribution center just like you would if you owned a home across the street and your tenant moved out, you got to find a new one and there's no rent coming in when the tenant leaves, which is one of the big gotchas in a triple net property is that it's either a hundred percent leased or it's a hundred percent vacant. The spigot's turned on with rent or the spigot's turned off. And that's why we like to see long-term leases with credit-rated tenants so that you can make sure that you have something that's a little more dependable.
We always want to caution folks to not get into single-tenant net lease properties with debt, though, because if that one tenant did go out of business or moved out at the end of the lease and you still have a loan on that property, it gets devastating or it could be devastating when you don't have the money to pay that mortgage payment because there's no rent coming in. One of the things we encourage you to do is stay debt-free when you can and especially debt-free on properties that have just a single tenant.
Should I stop for a minute and let you ask questions before I get into some of the pitfalls?
Matt McFarland:
Yeah. There was so many amazing things that you just said. I was jotting down so many notes that I would love to expand on, but I don't know if we'll have time to get everything, but what I wanted to highlight in what you said really started with the concentration risk in terms of investors allocating or needing to allocate such a large portion of their net worth to purchase a single triple net asset on their own. A lot of these properties can be anywhere from a million and a half up to $3 5, 6 plus million. In terms of the average DST investor that we're working with mean most folks have networks in the range of two to $20, 30 million. You can imagine if someone is needing to allocate such a large amount of their capital to purchase one property, that creates a fair amount of concentration into that one project, especially when you add the debt on top of it. So I definitely wanted to highlight that aspect, Betty.
And another thing just to expand on quickly and then I'll let you get into a little bit more of the pitfalls, has to do with some of the risks that are involved with this property type specifically. There's always two sides to every coin and most investors are attracted to this asset class specifically because there's a higher degree of predictability. Usually, when we're talking about investment grade companies that are signing long-term lease obligations, it's fairly easy to predict the amount of revenue or income that's going to be paid through the tenant's lease obligation, especially if they're a multi-billion dollar investment grade company.
And the other side of that coin is that these properties, a hundred percent of your revenue is coming through one source and there will be a date, there will be a day of reckoning where that tenant is going to decide if they want to stay and continue to operate in that property or if they're going to go. And there's always the risk, like you mentioned, Betty, that even the FedExes of their world they could go out of business. So with the DST approach, investors are still able to participate in this type of ownership class of real estate, but do it on a more diversified basis. God forbid the FedEx goes out of business, 50% of their net worth isn't allocated into that one investment and that one revenue stream.
I'll take a pause there and I'll let you keep going with the potential pitfalls, but really appreciate everything that you're bringing.
Betty Friant (19:36): What are some of the potential pitfalls of investing in a single tenant net lease property? (Back to Top)
I liked your summary. That was really good. And it's interesting because during COVID, it was really eye-opening because some of the big tenants like Starbucks sent out a letter saying that they weren't going to pay their rent during COVID even though they had lines of cars around their buildings. But what they did is they sent out the letter saying they're not going to pay and many of the Starbucks restaurants are owned by mom and pops who have mortgages on them.
Here they get this letter from this multi-billion dollar company saying they're not going to pay their rent and what do they do? Go out and hire a really expensive lawyer to try to fight Starbucks? That's really a scary thing to have to do. And then if you do negotiate a delayed or a deferred payment, you have to then figure out how to manage that, how to do it. You have to get a lawyer to read it because Starbucks does it all the time, or big companies do it all the time. And we as investors only do it every now and then, so it's really hard when you're negotiating with a huge company like that, which, bringing it back to the DST world, I don't want to be the one who's negotiating even though I've been in real estate for so long, but I don't do that on a daily basis.
I don't want to have to be the one negotiating with that company, and I don't want to have to be the one to find that new tenant if we need a new tenant in a distribution center or a medical office or whatever it might be. I want somebody like a DST sponsor who has resources and experience. I want them being able to manage that type of situation because triple net is supposed to be easy and no landlord responsibilities. But I know that I wrote a blog, I don't remember when it was, but it was during COVID and the title of my blog was, This Isn't What I Signed Up For. Triple net landlord's dilemma because we were getting so many calls or landlords were getting so many calls about it not being as hands-off as they were hoping it is. And that's why the professional management of a DST company felt good to me. It made sense to me and why I came into the business.
It's also funny because you were talking about net worth. In my triple net days, people with a net worth of $2 or 3 million would be buying a franchisee Wendy's. And I love Wendy's and I love franchisees, but if you're getting a $2 million loan, putting a million dollar down, signing your life away basically on a recourse loan where the bank can come back to you if something happens to that franchisee, again, that's just so much concentration. So makes it really scary to have that.
Just in the operations too, when you have a triple net property, you really do want to make sure that they are taking care of the building, that they are honoring the terms of the lease. Some cases you have to pay the taxes and insurance and get reimbursed by the tenant, or there's CAM Common Area Maintenance Charges that you have to collect, pay, and then bill out to the companies that are renting for you. With the DST, again, it's something where not only is all that done and typically you get a quarterly report telling you about that. And I have to admit, sometimes for single-tenant net lease properties, the quarterly reports are pretty darn boring because they say things like, "That tenant continued to pay as per the PPM," and there's not very much news on it.
But even having the monthly distributions, hopefully, as long as the tenant pays rent, you get your distribution, the quarterly reports, and then at the end of the year, we've all just gone through this, you get a done-for-you, done-for-you taxes, you just take the paper and hand it to your CPA or unless you do it yourself, you put it on your Schedule E and just like your other rental properties, you're good to go. It goes on the Schedule E, you get the same deductions for real estate and you're on your way, but you don't have to do it, that's my goal. And DSTs really are a lifestyle change, but it's funny for me, DSTs give me the opportunity to be able to work because I'm a workaholic and I'm crazy, but also time for other things, golf, tennis, pickleball, whatever you do when you have the DST, somebody else's doing it for you. So you can relax a little bit or work a little more.
I'll stop again. Your turn.
Matt McFarland (24:47): Passive ways to invest in single triple net or a single-tent net lease properties (Back to Top)
I think that's so key. And a lot of people attribute triple net real estate as one of the most passive ways that they can go. One considering a 1031 exchange. And I love what you said about DSTs being the most passive, right? This is the most passive way that an investor can pursue a like-kind exchange as all these properties, there's professional asset management that is taking care of the ins and outs of everything that happens on that real estate and the management efforts there.
You used the word boring and for many of our investors, boring is exactly what they want. They want an investment that someone else is doing the work for them, an investment where there aren't any major changes one way or another.
Another thing I wanted to point out too, I would say a majority of our investors, not all of them, but a majority of them are coming from owning some type of residential property, whether that's a small multifamily, or individual single-family rentals. That's where their experience has lied over their experience in real estate. And there is a lot to learn as it relates to not only acquiring these types of properties but also continuing to manage them, like Betty gave a few examples. Not only is it not something that investors have experience with that could lead to potential risks, but also a lot of our investors, they're not wanting to reinvent the wheel. They want to transition into more of a retirement lifestyle. And the DSTs in allowing them the ability to diversify and also access a higher caliber real estate asset with not needing to buy the entire property on their own really provides them the ability to check all the boxes that they're initially looking for.
The last thing I'll say, and then I'll ask you, Betty, one more question as we close out, is the triple net properties and the DSTs go hand in hand, I think a lot of people are initially maybe a little confused in terms of the triple net property describing the lease arrangement and the DST describing the way that the real estate deal is structured. They coexist, they both coexist. And for a lot of our investors investing in a DST into a triple net or a single-tenant-net-lease property can offer many of the same advantages, if not additional advantages, that we talked about here to satisfy what they're trying to do with respect to their exchange. The last thing I want to close out Betty and just ask you very quickly if there's anything else you want to add as we close out the call and put a nice bow on our conversation today.
Betty Friant (28:24): Closing risks involved in independently purchasing a net lease property. (Back to Top)
Perfect. You talked about my using the word boring, and I know there's that quote out there, but with everything that's going on, I would like to live in boring times. They say, "May you live in interesting times," and I think, "Nah, let's live in boring times right now." But one thing that way to make life boring is to not have closing risk. So I just wanted to bring this up right at the end. When you're buying a property like a triple net property, not only do you have to go out there and make a ton of offers to try to get one, even though the market's slowed down, they're still hard to find good ones. And once you get the offer done, because it's usually not just a plain contract, it has to be negotiated between everybody's attorney, so that takes time. Then you have to order all your third party reports, and that takes time. All of that in that 45-day window for a 1031 exchange can get pretty scary.
With the DST, all those reports are already done. The property is already bought. You get to see everything, study everything, look at our due diligence, do your own due diligence, and the closing risk is basically gone. You just get to pick it because it's on the shelf. And just like you wouldn't buy one stock and put all of your money in one stock, putting all your money in just one triple-net property is crazy too, and the DST gives you that basic ability to be able to mix it up a little bit.
(30:03):
And then I am going to say, because I can't leave without saying this, we always want you to think in terms of staying debt-free if you can, that's a topic for another week. And also to avoid risky asset classes, there's some triple net properties that are just risky to begin with and we can go over that with you either on another call or give us a call and we'll break that down for you, as well.
(30:28):
I'll end there, you wrap it up.
Matt McFarland (30:32):
No, I think that's perfect. So I really appreciate your time Betty, and all the useful information you brought to the table today. And I want to thank our listeners, too, for carving out 30 minutes on your Friday leading up to a holiday weekend. We really appreciate your time.
(30:49):
As mentioned at the beginning of the call, we do host this conversation live every Friday. So please, do join us next week, next Friday at 11 o'clock Pacific or two o'clock Eastern on DST Essentials with Kay Properties.
(31:03):
With that, everyone, have a wonderful Memorial Day weekend coming up and we look forward to speaking to each and every one of you very soon.
(31:12):
Thanks everyone, and take care.