When One Door Closes……

Author

Ken Wimberly

Recently the NNN operations of our brokerage have had a lot of activity with short term/high cap rate existing NNN properties.  This is a new product type for us and it required me to go through a quick learning curve on the differences in analysis between these properties and the new or pre-development NNN properties that many of our clients develop.

Every NNN owner’s primary concern is the risk of losing the tenant.  This risk can be mitigated by enduring one of (if not both) two things:

1. Long term viability of the tenant from an industry-wide, corporate, and store level aspect.
2. Intrinsic value of the real estate.

These considerations are made with every NNN deal, not just the short-term lease type.  Yet the tenant loss seems like much more of a problem when there are 5 years remaining on the lease term rather than 20. As brokers making an effort to market these shorter-term deals, we have learned that viability of the tenant becomes less of an underwriting point as the real estate value.  Each investor will look at these properties operating under the assumption that the tenant will vacate and it becomes a matter of “when” rather than “if”.

There are many ways to evaluate these deals from a buyer’s perspective.  One is a function involving market cap on new leases, replacement cost, and ending up somewhere in the middle.  Another is to take the net present value of the guaranteed lease payments with a minimum rate of return and adding the market value of a vacant building in that market.  However, running through the numbers 100 different ways with a buyer will still yield the same question: “What do I do when the tenant leaves?”

The answer: Backfill.

This is a concept that is outside of many investors’ comfort zone; and as a broker getting a prospective buyer comfortable with the idea takes some work…. but with a little bit of research you can see is the viability of this option.  Recently, we were working on a short-term Dollar General deal.  Prior to discussing the prospect of backfilling we did some research to see if it was possible for this site.  To be honest, I didn’t think it was.  Nevertheless, using a database we entered in the size, demographics, traffic counts, co-tenants, etc. and found almost 20 corporate tenants that would be a match for this particular site.  Add in the fact that the current tenant is paying half of what the market rent in the area is and this deal became a lot more attractive.  Suddenly, from an investment standpoint you want the tenant to move out so that the next tenant can pay market rent and the investor can double his return/value.

The point that I would like to illustrate is that the fear of uncertainty regarding a property’s value at the end of a lease can actually be a great opportunity for the right investor.  In my opinion, a lot of investors ignore an asset’s potential beyond the remaining lease term.  It may stem from the “bond buying” mentality of some investors or the lack of comfort with the risk involved; but one thing to remember is that a real estate asset is one that has income producing potential for as long as you own it…not just until the end of the existing lease.

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