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.
However, just like any investment, there are risks involved.
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 NNN 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 NNN property and if things don’t go exactly right with the property or tenant, the consequences could be disastrous.
A Potential Solution
Many 1031 exchange investors are opting to instead of purchasing just one NNN property with a large portion of their net worth, to purchase fractional interests in NNN properties to build themselves a diversified real estate portfolio. As an illustrative example, 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 NNN 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.
