Potential Pitfalls of NNN Properties and a Savvy Alternative

A woman calculating potential pitfalls of NNN properties

By Chay Lapin, President, Kay Properties and Investments

  • NNN properties seem like passive investments but actually require regular management. 
  • Overconcentration is a key risk when it comes to investing in NNN properties.
  • DSTs (Delaware Statutory Trusts) provide an alternative way to invest in NNN properties.
  • *Diversification* and true passivity are unique advantages of DST investments.

Frequently investors are seeking out reduced management and or passive real estate investments. Real estate owners are simply tired of the three T’s (Tenants, Trash, Toilets) and are looking for alternative options to consider. 

One option that a lot of investors are being sold by their real estate brokers are Net Leased properties, which are commonly known as “triple net leases” (or “NNN”). Some Net Lease properties can be nearly 100% passive. Investors will want to carefully understand how the unique net lease is set up, as some leases may actually have active management responsibilities for building upkeep. A client will also want to keep a monthly check in to make sure that the tenant is abiding by their net lease structure and that they are actually paying the various bills (e.g. Common area expenses, Property Taxes and Insurance). It is not uncommon for a large corporation to have a glitch and be late paying property taxes, and this could affect your building if not caught in an appropriate time frame.

If an investor is going to be placing their entire 1031 exchange proceeds or cash allocation in one net lease property, there are key points that an investor should understand prior to investing: 

  • Concentration Risk – Placing all of your eggs into one basket
  • Tenant bankruptcies and restructuring – Lease Rejection
  • Store Closures – “Dark Stores”
  • 1031 exchange closing risk
  • Asset and property management responsibilities – unpaid tenant taxes, collecting reimbursements, refinancing, lease term burn off and value erosion, lease renewal, and negotiations, legal expenses, insurance issues, etc.

Another option for investors that are looking for a 100% passive investment is a DST (Delaware statutory Trust). A DST is an entity that can hold investment real estate structured to take 1031 Exchange monies and after tax dollar investments. DST properties can be used as opposed to NNN properties but still providing access to net lease type properties (FedEx, Amazon, Walgreens, CVS and many others). Potential Diversification – Don’t put all your eggs into one basket! It is important to note however that diversification does not guarantee protection against losses or guarantee profits.

  • You can close potentially on a DST in 2-3 days – helps to potentially reduce 1031 exchange closing risk.
  • Non-recourse financing with DSTs as opposed to partial and full recourse with NNN properties.
  • Back up – Use a DST as a backup ID in case your NNN deal falls apart.
  • DST as a home for leftover funds to cover your exchange and avoid boot.
  • Professional asset and property management in place.

DST examples:

DST # 1
A portfolio of 15 corporate-backed FedEx distribution facilities, Walgreens pharmacies, and CVS pharmacies located throughout the country.

DST # 2
A portfolio of 20 single tenant net leased properties to tenants such as CVS, Tractor Supply, McDonald’s, Advanced Auto Parts, Auto Zone, DaVita Dialysis, Dollar General, and Dunkin Doughnuts.

DST # 3
A single tenant VA Medical Hospital on a 20-year lease with the General Services Administration (GSA) – The United States Government 

Potentially protect yourself and your family by investing in multiple DSTs. This allows your 1031 equity to be diversified over 100 to 300 million dollars worth of institutional quality real estate,  instead of buying one 1-3 million dollar net lease property and having to actively manage it yourself.

*Diversification does not guarantee profits or protect against losses.