I've owned REITs for years but have never seen NNN REIT before joining this board. What are they? sorry to come on so square.brucedoe
A "triple-net lease" (NNN) is one where the landlord only supplies the building. The upkeep, energy costs, taxes, etc are all responsibilities of the lessee. This supposedly makes the building a lower risk to the landlords cash-flow, but exposes him more to rising interest rates.Examples include small buildings (Commercial Net Lease Realty), golf courses (TEE and GTA).
I think the term is a little misleading. A triple-net lease is as StockDoct defined it. But, triple-net leases are commonplace for lots of REITs that are not Triple-Net REITs. Triple-Net REITs, or Net-Lease REITs as they are sometimes called, not only use triple-net leases but also are characterized by many or all of these characteristics:1) Single-tenant properties2) Sale lease-back transactions3) Long-term leases4) Absence of in-house development capacity5) Absence of in-house property management capacityExamples: TRI (now gone), GTA, CARS, NNN, O, TEE.Many healthcare and hotel REITs would share these characteristics.Being conservative and income-oriented, I was initially attracted to this species, since it would seem to be a low-risk business plan. But, the reality has seemed to be otherwise: The passivity of the model leaves little room for management to add value. The insulation from the marketplace (single tenants on long-term leases, often being the same entities as the sellers of the properties) deprives investors of the market-based confirmation of the value of the property. The simplicity of the model perhaps attracts managements & stock promoters who have little capacity, and, combined with the aforementioned insulation from marketplace, several of these have turned out to be ticking time bombs. I've decided proven strong management with a more challenging business model is actually lower risk than the opposite. One man's opinion.
Perhaps another way of looking at the distinction would be to distinguish those REITs that function as real estate operating companies from those REITs that function solely as financing companies.In many respects, residential REITs (e.g. EQR, PPS, AIV) function as landlords, in much the same manner as privately held real estate companies. They worry about ongoing profitability of their properties, maintenance costs, etc. as landlords, not merely as financiers. Maintaining tenant occupancy on a community-by-community, day-to-day basis is the lifeblood of such entities. In contrast, pure triple-net REITs generally rent the land, building and infrastructure of an entire property to a single tenant who is solely responsible for the operation, maintenance, upkeep, etc of the property. Under a typical NNN REIT lease, the tenant generally remains responsible to pay the rent and rebuild, even if the property is destroyed by fire or other casualty. NNN REITs thus do not tend to operate as landlords but essentially function as financing sources providing their "tenants" with so-called "off-balance sheet" financing secured by the real estate acquired in sale-leaseback transactions. Such NNN REIT financing often provides the tenant with a needed source of mezzanine level capital while removing debt from the tenant's balance sheet. The NNN REIT functions as a spread lender, reaping the positive arbitrage between the REIT's blended cost of capital and the financing rate inherent in the lease payment. The only manner of generating growth in such entities is either (a) to increase rents from the existing portfolio (generally unlikely since the leases are long term with pre-determined rent levels) or (b) to expand the portfolio with new and accretive property acquisitions (which has become increasingly difficult as (i) capital for brick and mortar infrastructure has become constrained, thus increasing REIT cost of capital and (ii) sellers' appraisals of the value of their property have remained somewhat inflated, making accretion difficult to find). To provide value for their shareholders, different management teams have implemented various strategies. For example, HR has acquired an inhouse management capability. Other NNN REITs have begun to develop properties inhouse or to operate as full real estate entities by purchasing mult-tenant properties which they now lease as landlords, thus broadening the company's scope from financing entity to full real estate operating entity.Hope this was at least somewhat useful.
RE: NNN REITsAn often overlooked aspect of the NNN REITs is that the leased properties are often mortgaged on a full pay out basis over the term of the lease. So, although it may be long term (15 to 25 years), at the end of the term the property is put under a renewed or new lease at (hopefully) not only a higher rental rate, but also debt free. Usually the NNN REIT would put a new mortgage on the property based on the new (renewed) lease and create some cash for other property acquisitions. Again, granted this is long term, but many NNN leases are over half way there and the present value of that value gets closer every day.
"An often overlooked aspect of the NNN REITs is that the leased properties are often mortgaged on a full pay out basis over the term of the lease."This statement is true for many, but not all, NNN REITs. As suggested, some NNN REITs employ a capital structure which relies on project/property level secured debt to fund payment of short term debt incurred to fund REIT acquisitions. This was most certainly the case with REITs in the late 1970s (and the demise of those REITs can be traced to a mismatch of shorter term property level debt coupled with long term leases, resulting in a squeeze when interest rates ballooned out of sight at the end of that decade). Many other NNN REITs, however, have historically relied on access to the public debt markets to obtain a portion of their capital. Those NNN REITs have employed secured debt solely on a limited basis (as required to maintain the best possible debt ratings from S&P, Moodys and Duff & Phelps and to obtain favorable treatment for short term bank borrowings which fund acquisition in the first instance). Such NNN REITs must balance the potentially advantageous rates available for secured debt against the potential adverse impact of such debt on the REIT's capital structure, overall debt rating and access to public debt markets at superior interest rates.Over the past 18 months or so, the public debt markets have become increasingly difficult for NNN REITs to access at attractive interest rates. As a result, some NNN REITs are turning to secured financing packages covering a portion of their portfolio in an attempt to maintain reasonable costs of capital while maintaining existing ratings on their corporate debt. This trend will likely continue for so long as secured debt rates are demonstrably better than rates available for any publicly issued debt. If, however, NNN REITs are able to access public debt markets at superior rates via higher corporate debt ratings, we should anticipate that the NNN REITs will refinance some portion of the secured debt.
Roasemane,Yes, your answer was very helpful.brucedoe
I expect that by the time the NNN leases are up in 15-25 years, the building may be debt free but expensive remodeling and renovation are in order.brucedoe
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