The Risks in Purchasing a Triple Net Lease Property and a Potential Solution

A triple net lease apartment buildling

By Dwight Kay and the Kay Properties Team

Purchasing a Triple Net Lease Property (NNN) provides many benefits to investors.  They’re usually single tenant retail, medical or industrial properties where the tenant is responsible for the majority of if not all of the expenses including insurance and maintenance costs.  They also provide a potentially steady cash flow to the investor as leases are often 10-15 years in length with multiple renewal options. For this reason, many potential investors look for single tenant NNN properties for sale with the goal of securing a steady cash flow. However, just like any investment, there are risks involved in triple net properties (NNN), which we examine below:

Vacancies

Triple Net Lease Properties (NNNs) are typically either fully occupied or totally vacant.  Since they only have one tenant, if the company goes out of business, then you have no rent coming in. That means you’re responsible for any debt service, maintenance, insurance and taxes.  When purchasing a NNN investors must be very cautious when it comes to the tenants business model and industry and the potential for disruption that future changes in technology could bring – think Blockbuster Video and Borders Books.

Lack of Diversification*

The problem for many 1031 exchange investors is that they often have only between 500k and 3 million of equity to purchase a NNN property and this equity amount comprises a large portion of the investors net worth.  Oftentimes, the most desirable triple net properties start at a 2 million dollar purchase price.  This can be problematic because the 1031 exchange investor is placing a large amount of his or her net worth into one building, with one tenant and that is in one location.  This often causes investors to over concentrate their net worth into a triple net property and if things don’t go exactly right with the property or tenant, the consequences could be disastrous.

Single Location Risk

Naturally, the location of your property can determine the level of potential risk. Any real estate investment, including triple net lease properties are subject to risk of location. How well-trafficked is the area? Is it blessed with a large population with a relatively high spending power?

When researching the triple net lease property for sale, it’s easy to focus on the high returns it has been generating. However, what will happen when the tenant leaves the property due to some unforeseen reason? At that point, the location will mostly drive the ability of the property to attract a promising long-term tenant with good credit. Is the location favorable enough to easily attract tenants from various types of businesses so that the property is never vacant? Or is the property situated in an unfavorable area that would draw very few businesses? Besides occupancy, location will also influence the rental rate.

Lease Length

A long-term lease contract guarantees a rental income for a period of 10 years or more. Therefore the length of the lease is a crucial factor that can help determine the value of triple net investments. It’s only natural that as the lease of a triple net property is about to expire, its value may reduce.

If a tenant is nearing end of the lease and is not open to renewing the lease, they should let the landlord know ahead of time about their plans so the latter has the benefit of a reasonable notice period within which to look for another tenant.

A Potential Solution

Many 1031 exchange investors are opting to purchase fractional interests in triple net lease properties to build themselves a diversified real estate portfolio instead of purchasing just one NNN property with a large portion of their net worth.  As an illustrative example, consider this: instead of buying just one Walgreens for 4 million dollars, because of lower investment minimums, investors are purchasing 500k in a Walgreens, 500k in a CVS, 500k in a Fresenius, 500k in a FedEx industrial facility, 500k in an Amazon distribution facility, 500k in a Costco, 500k in a Starbucks and 500k in a US Government Leased building.

This diversified real estate portfolio of triple net lease properties allows investors to potentially mitigate concentration risk and reliance on one tenant and potentially losing their entire principal if that one tenant goes bankrupt. Of course there is still a risk of losing the entire investment, but is will be spread across multiple tenants. Investors are doing this through what is called a Delaware Statutory Trust or DST. The DST has been blessed by the IRS as like kind for the purposes of a 1031 exchange via IRC Revenue Ruling 2004-86. Diversification does not guarantee profits or protect against losses. 

*Diversification does not guarantee profits or protect against losses.

About Kay Properties and www.kpi1031.com

Kay Properties is a national Delaware Statutory Trust (DST) investment firm. The www.kpi1031.com platform provides access to the marketplace of DSTs from over 25 different sponsor companies, custom DSTs only available to Kay clients, independent advice on DST sponsor companies, full due diligence and vetting on each DST (typically 20-40 DSTs) and a DST secondary market.  Kay Properties team members collectively have over 115 years of real estate experience, are licensed in all 50 states, and have participated in over 21 Billion of DST 1031 investments.

This material does not constitute an offer to sell nor a solicitation of an offer to buy any security. Such offers can be made only by the confidential Private Placement Memorandum (the “Memorandum”). Please read the entire Memorandum paying special attention to the risk section prior investing.  IRC Section 1031, IRC Section 1033 and IRC Section 721 are complex tax codes therefore you should consult your tax or legal professional for details regarding your situation.  There are material risks associated with investing in real estate securities including illiquidity, vacancies, general market conditions and competition, lack of operating history, interest rate risks, general risks of owning/operating commercial and multifamily properties, financing risks, potential adverse tax consequences, general economic risks, development risks and long hold periods. There is a risk of loss of the entire investment principal. Past performance is not a guarantee of future results. Potential cash flow, potential returns and potential appreciation are not guaranteed.

Nothing contained on this website constitutes tax, legal, insurance or investment advice, nor does it constitute a solicitation or an offer to buy or sell any security or other financial instrument. Securities offered through Growth Capital Services, member FINRASIPC, Office of Supervisory Jurisdiction located at 582 Market Street, Suite 300, San Francisco, CA 94104.

Email this to someoneTweet about this on TwitterShare on FacebookShare on LinkedIn