Seven Things to Consider When Buying a Triple Net Property
Purchasing a property with single tenant triple net lease ("Triple Net Property") is a common investment tool for investors seeking a passive stream of income. Triple Net Properties can be a great investment for both sophisticated real estate investors and people who are new to the real estate investment world. Regardless of your experience level, when looking to purchase a Triple Net Property, there are a number of factors to consider.
- The Creditworthiness of the Tenant. In the short term, the creditworthiness of the tenant is one of the most important factors when considering whether to purchase a Triple Net Property. When purchasing a Triple Net Property, you are generally purchasing the property for the steam of income generated by the rent under the lease. A creditworthy tenant is more likely to make timely rent payments, ensuring the Property has a constant payment stream. Generally, publicly traded companies are more likely to be creditworthy tenants than private companies. Nevertheless, publicly traded companies are still susceptible to market conditions, and it is not uncommon for large publicly traded companies to close multiple locations during difficult economic times. Regardless of the tenant, it is important that the letter of intent and purchase and sale agreement for the property include a requirement that the seller provide an operating statement for the Property and any financial statements or other financial information of the tenant that the seller may have in its possession.
- Location of the Property and the Form of Building. While the creditworthiness of the Tenant may be the most important short term financial consideration of a Triple Net Property, the location of the property and form of the actual building may be the most important long-term consideration. Tenants come and go. The Triple Net Property needs to be attractive to other tenants in the event your tenant ceases operation on the property or the lease terminates. It is important to find a Triple Net Property that is in a location with easy street access and is clearly visible to those driving by it. It is also important to consider the form and make-up of the building on the property. If the building is fairly specialized it is going to be more difficult and more expensive to lease it once the current tenant leaves. For example, a building occupied by a brewery and designed to house massive fermentation tanks and kegging and bottling machines is going to require serious modifications to be ready for any tenant aside from another brewery. Buildings that are more of a “vanilla box” will be much easier and less expensive to re-lease once the current tenant leaves.
- True Absolute Net Lease. As referenced above, Triple Net Properties are generally used as passive investment tools. In order to have a passive investment, the lease for the property needs to be an absolute triple net lease. The lease should require that the tenant is responsible for the payment of all taxes, utilities, common area expense, and requires the tenant to maintain the building in its entirety. A copy of the lease should be provided to you prior to, or simultaneously with, entering into a purchase and sale agreement for the property and should be reviewed by a commercial real estate attorney to assess the possible liabilities associated with the lease. If a new lease is going to be executed at closing, a provision should be included in the purchase and sale agreement requiring the lease for the property to be an absolute triple net lease.
- Term of the Lease. In the short term, you are buying the Triple Net Property for the income stream generated by the rent from the lease. If the remaining term of the lease is short, your income stream will be short as well. Re-leasing the property is also expensive. If the lease term is short, not only will you have a reduced income stream, but you’ll be required to expend more funds to re-lease the property once the term ends. In order to avoid this situation, consider buying a Triple Net Property with lengthy remaining lease term (i.e. approximately ten (10) years or more). However, if you like the Triple Net Property as a long term investment and the lease has a short remaining term, consider requesting a price reduction from the seller to offset some of the costs associated with re-leasing the property.
- 1031 Funds and Timeline. You may be using 1031 funds from the sale of a relinquished property to purchase Triple Net Properties. This is a common and wise use of 1031 funds. However, you need to be mindful of the time periods associated with the 1031 funds. After selling the relinquished property, you have forty-five (45) days to identify properties that you intend to buy with the 1031 funds. You also have one hundred eighty (180) days (the "Exchange Period") after the sale of the relinquished property to use the 1031 funds to purchase the properties you have identified. You need to be able to close on the Triple Net Properties before the Exchange Period expires. Confer with a commercial real estate attorney to confirm that due diligence review can be completed and closing can occur before the end of the Exchange Period.
- Rights of First Refusal. Some Triple Net Properties include rights of first refusal ("ROFR"), giving the original developer or tenant of the property the right to purchase the property before any other party. ROFR can pose an issue if you are buying the property with 1031 funds. If the holder of the ROFR exercises the right before you close on the property, you will have wasted valuable time during the Exchange Period and may be scrambling to find another property to buy before the Exchange Period expires. Be sure to inquire with the seller of the Triple Net Property about any ROFR before executing a contract to purchase the property and engage counsel to review title to ensure that no ROFR exists. Regardless of whether 1031 funds are used, if a ROFR exists, obtain a waiver of the ROFR from its holder prior to letting your earnest money become non-refundable.
- Engage Legal Counsel. When purchasing a Triple Net Property, you need to be sure that you have sufficient protections under your purchase and sale agreement, you are receiving good title to the property, the property complies with all applicable laws, and there are no environmental issues affecting the property. Purchasing a Triple Net Property with any defects to these items can destroy the value of your investment. It is important to engage a commercial real estate lawyer to review or draft the purchase and sale agreement, and review title, survey, and other due diligence. Your lawyer will also be able guide you through any potential pitfalls that may arise during the purchase process.
If you need assistance purchasing a Triple Net Property or any other component of your commercial real estate transaction, please contact the commercial real estate attorneys at Thompson Burton PLLC.