Triple Net Leases or NNN have become a popular investment vehicle for many investors due to their “low-risk, steady income” nature. However, NNN works a little differently than other real estate investments, especially when it comes to underwriting.
In this article, we’ll help you familiarize yourself with the basics of NNN underwriting to help you get an idea of how this type of lease works.
Analyzing the Tenant’s Financial Strength
In every NNN arrangement, there’s always a clear commitment from the tenant to pay the rent for the duration of the lease term and potentially additional expenses like repairs and real estate taxes. That’s why the first thing underwriters need to do is analyze the tenant’s capability to bear all that financial responsibility.
Lenders and underwriters would typically check if the tenant is a public company or has issued bonds on the public market. Underwriters can use them to track and measure the tenant’s ability to bear the financial responsibility throughout the lease term if they have any of these.
Knowing the Specifics of the Lease Commitment
Another important factor underwriters need to consider is the specifics or characteristics of the lease commitment. For example, if the lease term lasts ten years, underwriters or lenders need to know if that’s something the tenant will be able to pay for and if they can commit to it.
This process often leads to further discussions and negotiations, especially if the tenant can barely commit to terms financially. In addition to the lease terms, underwriters also look into answering the following questions:
- Will the landlord have any sort of responsibility when it comes to the property’s upkeep?
- Will the tenant have the option to renew at the end of the lease term automatically?
- Will rent change throughout the term or upon renewal?
- Will repairs and maintenance costs fall on the tenant or the landlord?
The Value of the Property Without a Tenant
A major concern for underwriters is to know what would happen if the tenant leaves during the lease term. They’ll look at the net income that can be generated by renting out all or some of the property without a tenant.
This will help them determine the property’s future value, especially if a tenant leaves during the lease term.
For example, let’s say the property generates $100,000 per year. If the tenant leaves halfway through the lease term, underwriters will have to calculate what can be generated if all or some of that space is rented out.
This would determine the value of the property after a tenant leaves mid-term. Underwriters then use this number as a reference point to assess the property’s potential value down the line.
- If 80% of monthly income can be generated by renting out 100% of the space that used to be occupied by the first tenant, underwriters can also use this number as a baseline for future growth or decline projections depending on whether or not another tenant moves in.
- If the space is only able to generate $60,000 without a tenant, that would mean that even if another tenant moves in during the term of the lease, there will still be at least $40,000 lost every month due to no active paying tenants. This means that once another tenant moves out, there may not be enough revenue to support the property.
Therefore, if an underwriter is considering a NNN investment, they need to know what would happen if the tenant leaves during the term of the lease. This will help them determine whether or not they can move forward.
Bottom Line
NNN properties are great investments. However, plenty of factors go on when underwriting NNN properties, and each of them needs to be carefully studied to avoid costly mistakes.
Always remember that success still heavily depends on how much you understand the process and how competent your team is at analyzing every aspect of the NNN property.
Brisky Net Lease is a highly experienced and respected institution when it comes to NNN properties.
Contact us today if you’re looking for a reliable partner for NNN investments. Our team would be happy to discuss the process with you.