Passive Investments: Triple Net Assets (NNN) vs. Cropland

Author

Ken Wimberly

Passive income has always been a vital key to building wealth, and real estate investment has long been a very effective avenue for passive income.  Many investors have sacrificed higher returns for security in more risk averse assets since the recession.  Of all the property types available for investors, there are two that dominate the risk averse market, NNN-leased properties and cropland, but which is a more solid investment?  And what separates the two from an investment underwriting point of view?

Triple Net Assets (NNN) are best viewed as a bond secured by commercial real estate.  The investor becomes the fee simple owner of the real estate, and tenant agrees to pay rent payments, as well as property taxes, insurance, and all common area maintenance (the three main expenses with real estate).  Typically, these assets return anywhere from a 6 – 8.5% return on a pre-tax cash on cash basis, depending on the tenant and lease.  Just like most assets, there is a risk vs. reward tradeoff.  Financially sound tenants with 15 – 20 year corporate guaranteed leases will provide a lower return than a start-up tenant with a short term lease and no guarantees.  However, the most prevalent risk in this type of asset is one that all real estate investors share, market risk.  The local and nationwide markets will likely change by the time the tenant’s lease is up, and either getting them to renew or finding a new tenant could be difficult.  The best way to mitigate this risk is by diversifying your geographical locations, your tenants, and having leases that come due at different times.

Cropland is a more abstract arrangement.  A landlord in the scenario will have two options, cash rent or sharecrop.  Cash rent is simply a gross lease on the land paid by the tenant farmer, and it is the landlord’s responsibility to pay all expenses (property tax and insurance).  Sharecrop is an arrangement where the tenant farmer and landlord split the expenses and profits from the crop at a percentage agreed upon between the two parties, usually anywhere from a 50/50 split to 33/67 with the tenant farmer getting the greater share.  In both scenarios, the landlord is exposed to the risk carried in the volatility of the commodity markets.  In a cash rent scenario, the farmer would still have to be able to sell his commodity for a high enough price to cover the costs of paying the cash rent along with rising fuel costs and other costs of production.  Before an investor even gets the chance to navigate the market risk, they have to deal with risk associated with having a crop, such as weather, fire, or other things that could destroy a crop in its entirety.  These two risk factors can be mitigated by purchasing 80-acre plots in different geographical regions, and having different crops planted on them.

Each property type has its own risks; it is the investor’s duty to evaluate a minimum rate of return to reflect that risk on a case by case basis.  In my opinion, the typical return on cropland does not reflect the risks involved.  In my opinion, a tornado wiping your crops away, or a decline in commodity markets is a lot more likely to happen than a corporate chain tenant going dark.  Therefore, cropland returns should be considerably higher, but that is not the case.  In a great year, cropland investments can produce up to 6.5% returns on a sharecrop basis, but they are more likely to be in the 4 – 5% range.   Of course, the return varies by region, crop, and year, but investors are bidding cropland out of the range of normal returns.  In other words, the demand they are putting on cropland is driving up the price to a point where returns are very dismal.  On the other hand, there is quite a bit of demand for NNN properties, but still plenty of listings to support the market and keep it in equilibrium.  Returns in the high 7% range are very likely right now, and with low interest rates, an investor could leverage these assets and see returns on equity above 10%.  To sum it all up, less risk and higher returns make NNN (Triple Net Assets) my preferred investment choice.

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